The double-entry model

The Double-Entry Model

Understanding the Double-Entry Model

  • The double-entry model of accounting is a fundamental concept that mandates every business transaction to be recorded in at least two accounts.
  • It is governed by the equation: Assets = Liabilities + Equity.
  • Every transaction impacts at least two accounts: one account gets debited and the other account gets credited.
  • Debit entries are made on the left side of an account, and credit entries are made on the right side.

Principles of the Double-Entry Model

  • The double-entry model adheres to the accounting equation, ensuring it is always in balance.
  • Basically, the total amount debited and credited for any transaction must be equal. This provides a system of checks and balances.
  • Debits increase assets or decrease liabilities, whereas credits decrease assets or increase liabilities.

Transactions under the Double-Entry Model

  • When an entity purchases an asset, it results in an increase in assets (debit) and a decrease in cash or increase in liability, if borrowed (credit).
  • When an entity incurs an expense, it results in a decrease in equity through retained earnings (debit) and decrease in assets, usually cash (credit).
  • When an entity generates revenue, there is an increase in equity through retained earnings (credit) and increase in assets, usually cash (debit).

Ledger Account and Double-Entry Model

  • In the double-entry bookkeeping system, the recorded transaction gets posted to ledger accounts.
  • Ledger accounts show the history and current balance of each of the entity’s accounts like assets, liabilities, equity, revenue, and expenses.
  • Ledger accounts help to prepare the Trial Balance, which tests the equitability of debits and credits, confirming they are in balance as per the double-entry model.

Role of Double-Entry Model in Financial Statements

  • The double-entry model plays a critical role in preparing accurate financial statements.
  • It ensures that the Balance Sheet, Income Statement, and Statement of Cash Flows reflect a true and fair view of the financial position of the company.
  • It aids in pinpointing errors, detecting fraud, and maintaining accurate records, thus enhancing the reliability of financial statements.