Legal Definitions - double-entry bookkeeping

Double-entry bookkeeping is a fundamental accounting system where every financial transaction is recorded in at least two different accounts. For each transaction, a debit entry is made in one account, and a corresponding credit entry is made in another account. This system ensures that the fundamental accounting equation (Assets = Liabilities + Equity) always remains balanced, providing a comprehensive and accurate view of a business's financial health.

Here are some examples to illustrate how double-entry bookkeeping works:

• Example 1: A small business purchases office supplies.

  Imagine "Green Thumb Landscaping" buys $300 worth of new gardening tools using its business debit card. In a double-entry system, this transaction would be recorded by:

  • Debiting the "Equipment & Tools" asset account by $300 (because the business now has more assets in the form of tools).
  • Crediting the "Cash/Bank" asset account by $300 (because the business's cash balance has decreased).

  This example demonstrates double-entry because one asset account increased (debit) while another asset account decreased (credit) by the same amount, keeping the overall accounting equation balanced.

• Example 2: A consulting firm receives payment for services rendered.

  "Strategic Insights LLC" completes a market analysis project for a client and receives a $5,000 payment directly deposited into its bank account. This transaction would be recorded as:

  • Debiting the "Cash/Bank" asset account by $5,000 (as the business's cash assets have increased).
  • Crediting the "Service Revenue" equity account by $5,000 (as the business has earned income, increasing its owner's equity).

  Here, both an asset account and an equity account increased, maintaining the balance of the accounting equation (Assets = Liabilities + Equity).

• Example 3: A startup company takes out a business loan.

  "Innovate Tech Solutions," a new software startup, secures a $20,000 business loan from a bank to fund its operations. The loan amount is deposited into the company's bank account. This would be recorded as:

  • Debiting the "Cash/Bank" asset account by $20,000 (because the company's cash assets have increased).
  • Crediting the "Loans Payable" liability account by $20,000 (because the company now owes the bank money, increasing its liabilities).

  This illustrates double-entry as both an asset account and a liability account increased by the same amount, ensuring the accounting equation remains balanced.