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6h10m
I find it a strange choice to explain double-entry bookkeeping with the example of "one entry for Alice, one entry for Bob". That's really not what it's about. It's obvious that a transaction with two parties could be recorded in two places, but to me the crucial point of double-entry bookkeeping is that it requires two entries for each party of the transaction. So if Alice buys book from Bob, four entries are made.
I get that this is supposed to be a simplification for educational purposes, but I find this is simplification is an oversimplification, since it omits the key point.
Every explanation of double entry accounting seems to do the same thing. If I'm trying to understand the double part of double-entry bookkeeping, what exactly does the "double" refer to? What's being "doubled"?
How would you salvage the article to actually explain the "double" part in detail? Could you do it purely from Bob's (or Alice's) perspective?
Remember, this was all done on paper before software with tagging and such existed.
I'll give a description shot, since I've been doing finance work recently. Other people can feel free to correct.
A company using double entry (as opposed to single) has a "chart of accounts." This means they have a bunch of imaginary accounts for tracking everything, including:
- Assets (e.g. cash on hand.)
- Liabilities (e.g. loans)
- Equity (e.g. investments in the company from outside parties)
- Income/Revenue: (edit: as PopAlongKid kid mentioned, I forgot this one. This could include sales revenue, but also things like interest.)
- Expenses (e.g. team lunch or a flight cost)
Some of these "accounts" may map to actual bank accounts: there is likely a liability account for a credit card or an asset account for the company checking.
Knowing all that, every time money is deposited or withdrawn (a transaction) the "double" references the fact that it's recorded in the journal (a.k.a ledger) of two accounts. (Edit: As bregma mentioned, one records where money is coming from and the other where it's going.) Often, an expense is often recorded in the checking "account" and the and the corresponding expense "account." E.g. a flight may be recorded in a travel expense "account," but you also record that the money came from the checking account. Every transaction is recorded in two places.
Beyond just being more accurate than single entry, this helps with important finance reports like Profit & Loss, since you can now see how money is moving around.
Edit: Now that I'm back on my desktop, these are a couple of useful links for understanding basic double entry bookkeeping: Accounting for Computer Scientists [0] and Accounting for Developers, Part I | Modern Treasury Journal [1]. What is a Sample Chart of Accounts for SASS Companies [2] illustrates some charts, which may be helpful for some folks.
[0] https://martin.kleppmann.com/2011/03/07/accounting-for-compu...
[1] https://www.moderntreasury.com/journal/accounting-for-develo...
[2] https://kruzeconsulting.com/startup-chart-accounts/
How do you determine which thing goes in which account, is it subjective or there is a formal way with a definition
In a general sense, it really doesn't matter, as long as you are consistent.
That said, there are accounting standards that define the general set of accounts for a particular industry, etc.
But every person having a set of books will want to customize it to some degree.
For instance in a personal set of books, if you want to track every person you pay, you might have accounts, 1 for every single person you have ever paid, ever.
That obviously can get pretty big! Others might not care that their electricity provider changed from Tootie inc. to Turtle inc, so they just have Utilities:Electricity as their account name.
Others might not care at all, and just have a very general "Expenses" account for things like that.
Make sense?
The important part is consistency of using the same accounts for the same transactions.
OK So it is somewhat open but you could use a set of standard accounts, I see.
Makes sense. Probably it's important to keep somewhat of a registers of accounts available to avoid making mistakes and to write directions on where things should go
There's also GAAP in the US and IFRS in Europe, which are standards for how certain things need to be done to be compliant. It's not specific about things like account names or how your ledger should be structured, but outlines many expectations and rules/constraints that build confidence in the resulting numbers.
Agreed, but every industry/sector might have their own set of standards that usually are overlays on top of GAAP/etc. For example in the US for state and local governments there is GASB: https://gasb.org
Of course! There is a standard term for that: Chart of Accounts
If you search for example chart of accounts <INDUSTRY YOU CARE ABOUT> you can probably get a sample set to work from.
The chart can differ in different companies or sectors. In my mind, it comes back to what you want to be able to report on.
Some companies may have a larger and more detailed chart of accounts so that they can have very specific breakdowns of things. I've heard of big charts where each of a company's departments have specific accounts and all departmental transactions go there while the rest are lumped into a "Sales, General, and Admin" bucket. (Although I think it's more common to tag transactions with a department code these days?)
That said, categories can be broken down into sub-types beyond Assets/Liabilities/Equity/Income/Expenses. For example, assets are categorized based on how quickly they can be converted to liquid money and if they physically exist. So, under the assets account you may have accounts for current, fixed, and intangible (e.g. trademark or domain name) assets and you would record those appropriately.
Edit: To answer the question more directly, it depends on the company and how they've customized their accounts or guidelines. But, there are general accounting practices that mandate the need for specific things and common questions to be answered, so a lot similar structures and guidance emerge that a company's finance team could use to tell you where something belongs.
So double entry is defeated if you uses a computer to enter the entries. For example if you brought a laptop for 1000, but you accidently wrote 2000 AND the computer automatically entered 2000 in the asset account it would still balance even though it was a mistake to enter 2000.
In addition, you can still make the same mistake by hand for both entries. So I’m still not getting how double entries catch mistakes
When you reconciled the balance in your bank account / credit card statement against that in your set of accounts, you'd notice the error as the statement balance would be 1000 higher than reflected in your accounts.
This is the real benefit I've encountered. Any time I try to "simplify" financial recording for someone else and avoid double-entry, I inevitably end up wanting to perform a query that would be easy in a double-entry system but is not in any other system.
Right. I didn't mention that a chart of accounts can look different in different companies/sectors. Some accounts may be considered nested (software may even show them as nested.) Then you can roll the totals for all accounts of a type into a general category account like "Assets" or "Expenses." That makes it easier to answer questions like, "how much have we spent in total?"
Thanks, I was sure I was missing something obvious like that when trying to simplify the explanation.
Every time money is exchanged, it has to come from somewhere and it has to go somewhere -- that's two places it need to be recorded (or "entered in the books").
Money can not be created out of thin air, and it can not be destroyed. Every movement of money has to be accounted for, which is why it's called "accounting". Double-entry accounting means you have to account for where the money comes from, and you have to account for where it goes, and each of those is a separate entry and it all has to add up to zero.
Where it can become confusing is when money leaves you or comes in from an external source. There are still two entries, but one entry is in one party's books and the other entry is the other's. For example, I get a paycheque and I enter my income in a little book with green paper and DB/CR columns. At the same time, my employer has entered an expense in their book. Double entries.
What if your company decides to be generous and just gave 1000 to random Joe, what is the double entry for that?
Cash account is credited $1000, and Gifted (or Cash_Gifted) account is debited $1000.
NO.
I mean your employer probably has a set of books, but that's not true in your own local set of books.
In your local set of books you would have something like:
You are accounting for ACME, Inc's Employment expense in your set of books too.When you send a payment to your Power Company:
I mean if you are categorizing expenses you might do something like that. If you aren't, you might title one account "Expenses" and spend it all there, it doesn't really matter what you call the accounts, just that you are consistent.> Money can not be created out of thin air, and it can not be destroyed.
Yet accounting is necessary because money is created out of thin air. Money is just the representation of debt, an IOU. There needs to be a record of it in order to know that a debt was created and that a debt was destroyed.
More practically, let's say you give me corn today, and I promise to deliver some of the chickens fed that corn to you after it is ready to for slaughter. Money keeps track of the promise outstanding. We record that promise, or account for it if you will, so that we remember that there is a promise and so that we can later ensure that the promise was delivered upon as agreed. Something that becomes especially important when you realize that promises can be traded on to other people who weren't party to the initial deal. Perhaps you don't really want chicken, but would prefer a watch instead. Luckily the watch maker would like to eat chicken for dinner down the line, so you give him the promise of chicken in exchange for the watch. So on, and so on.
Realistically, double-entry accounting is really quadruple-entry accounting. You record that something was received and you record that a promise was made, then, later on, you record that something was delivered as promised and also record that the promise is no longer outstanding (or in reverse if you are on the opposite end of the transaction). A profit indicates that people still owe you things that you haven't collected upon. A loss indicates that you still owe people things that you haven't yet delivered.
>Where it can become confusing is when money leaves you or comes in from an external source. There are still two entries, but one entry is in one party's books and the other entry is the other's. For example, I get a paycheque and I enter my income in a little book with green paper and DB/CR columns. At the same time, my employer has entered an expense in their book. Double entries.
I agree with your first two paragraphs but not with this last one. When money leaves you or comes in from an external source, there is always some proxy account for that external party in your own books. And the whole situation is mirrored in the accounting system of the external party (unless they are a consumer). Each party records two entries.
It’s a checksum; by decomposing every transaction into a double of (credit A, debit B) that must sum to zero, you catch random arithmetic errors.
You can think of it as “conservation of value”, so you can’t just create money out of thin air in your payment service (credit), without tying it to some account with a corresponding debit.
This originally was intended to protect against typos; eg write a 10 instead of 100, at the end of the day your ledger needs to balance. In software typos are less likely bit it still provides auditability to prevent a large class of bugs from wiping you out.
Double entry bookkeeping is much older than typing, but, yes, its a check against incorrect entries.
Speaking of history, I learned that the word "control" comes from contra rotulus -- roughly "checking against the wheel", which was apparently from an early medieval device for keeping tallies. The second meaning of "domination" came later.
Babylonian dogs walking on your clay tablet.
Bob and Alice each have a "money" account and a "books" account. Each money account tracks how much money they have on hand while each books account tracks the total value of their private libraries.
So to be clear, there are 4 accounts. Bob's Money, Bob's Books, Alice's Money, Alice's Books.
Because these two homeless librarians only have money and books, you can add the two balances together for each person to get their net worth.
If Alice owns 3 books worth $120, then the "Alice's Books" account would show a balance of $120. Meanwhile, Bob has 12 books worth $700.
When Alice buys the books, she -credits her bank account $20 and +debits her books account $20 (the value of the new book). Thus her net worth stays the same, but she has more books assets and fewer cash assets.
Similarly Bob -credits his books account $20 and +debits his bank account $20. His net worth also stays the same but he now has more cash than before.
On Alice's way back to the bridge she resides under, it starts to rain. Alice's new book is ruined. She -credit's her books account $20 and her net worth goes down by $20.
Life as a homeless librarian is harsh.
Stupid question maybe.
Is net worth an account too? Where does the debit side of Alice’s credit go?
In a real world example you would be correct. This would fall under the “equity” of the accounting equation assets = liabilities + equity. The equity part can be confusing but is where many of the non obvious second entries end up.
From what I got out of the article and my own limited understanding of double entry bookkeeping, the "double" seems to be referring to the part where we split a transaction into credits and debits as opposed to a transaction with positive or negative balance. The doubling is happening with the labels we use to describe what's happening with the money.
From an individual account perspective, there's a doubling of the number of columns you could enter a transaction's amount into.
this is probably not true, but I heard that this stuff predates the idea of negative numbers so you have db and cr accounts that offset each other without negatives.
The core innovation of 'double entry' is that you can see the flow of money between accounts for every transaction.
This is possible because you (the accountant) are always adding a back-reference from the other account (hence the 'double' in 'double entry').
There's really not much to it. It throws people that are new to it for a loop, I think, because it is a strange way of behaving, and it isn't obvious why you're doing it until you have to track down something that doesn't balance. It's just a disciplined behavior that accountants started using because it allows one to track things that were difficult without it.
The 'double' in double entry book-keeping is related only to the book keepers own records/books. It has nothing to do with counter party's record keeping.
If Alice purchases a house worth $100,000 in cash, then 2 (double) accounts will get effected. Her cash account will decrease (Credit) by $100,100 and simultaneously her House equity account (or any other appropriate name such as immovable asset etc) will increase by $100,000 (Debit).
This can be recorded in a 3 column table as
In the above transaction, two accounts were effected. Hence the name double entry. This gives a truer picture of ones assets and liabilities.Note: 1. Debit and credit dont have much to do with increase decrease. 2. A transaction can be modelled to have affect more than 2 account. For example if Alice were to make the purchase with $80,000 loan, then the book keeping could go like
For the sake of better understanding, if one is uncomfortable with having one record affecting 3 accounts, one can be more robust and split the loan and the purchase into 2 transactions. After all, taking a loan and purchasing a house are 2 different events(transactions). edit 1: attempt at better formattingDon't forget the depreciation, interest, maintenance, and tax accounts if you want to track those against the real estate cost basis for various purposes. You also need to figure out how to create and map accounts to IRS rules or you could put yourself in a real bind when it comes to figuring out tax liabilities or deductions.
Because double-entry accounting requires two (thus "double") entries for each transaction (i.e., Alice buys a book)
- one for the assets/liabilities account involved in sending or receiving the money ($30 credit, bank account) - one for the income/expense account to which the transaction corresponds ($30 debit, "education" expense account)
one of the two entries is a credit and the other a debit
Think of a ledger as a list of transactions. Transactions are directed hyper-edges: they are composed of a set of credits and a set of debits. For each transaction, the sum of debits must be equal the sum of credits. "Double-sided" might be a better term. Also a DAG doesn't convey the historical aspect of a ledger, each ledger should be conceived as a sequence diagram lifeline. See temporal graphs: https://teneto.readthedocs.io/en/latest/what_is_tnt.html#add...
Going further with this model, you could introduce the notion of higher-order links between transactions to keep related entries together, for instance to link a correcting transaction to the corrected transaction, grouping recurring payments for a loan together and so on.
You could (should!) model this on top of a bitemporal database to overcome the painful limitation of the event sourcing model, namely that corrections aren't retroactive. Imagine you need to establish due taxes for the past year for certain ledgers in your database, and for some of them you performed corrections to transactions for that fiscal period after the fiscal period ended. With an event-sourced model (a single timestamp for each transaction), the corrections won't impact your tax calculations unless you explicilty track those corrections in your query. But with a bitemporal model (two time axis), you'll be able to record both the time when you made the correction and when it should apply in the past and you'll be able to query your database normally, without even thinking about it. This could also be used to perform corrections that remain invisible to your customers while being fully tracked in your db. Another case were this could prove to be useful is with transactions that are not immediate and can be rolled back. Typically in these situations, you move money from one ledger to a counterpart dedicated temporary outgoing ledger before the transaction is confirmed. This allows you to prevent double spending. Using a bitemporal model, you could get rid of these temporary counterpart ledgers provided you add a status field to your transactions.
$100 appears in your account. That’s one part. The other part depends on why.
* you moved money from another account, the double is -100 in that account.
* you sold stuff, +100 in income.
* you borrowed some money, +100 in ‘debt’.
In a physical book each of these categories would have a left and right column, and each transaction has numbers in one left and one right column. Or in many columns but the sums of left vs right columns must be the same.
In all fairness, if you're trying to understand a piece of software like Quickbooks and are not coming from an accounting background, anthropomorphizing each "account" at your company as an individual actor with their own ledger can actually be a helpful mental model. Everything needs to be a dance between actors, and, for instance, when you make a vendor payment in cash, you can only do so as a message sent simultaneously to the Accounts Payable actor and the Cash actor, and each actor must accumulate the effects of that message/event in the way that makes sense. (Namely, each one will translate the event into credits/debits based on the characteristics of who they are, and maintain a balance accordingly. Double-entry, I suppose, means each event must be ingested exactly once by an even number of actors.)
If you're building payment rails, that event might itself be one of a pair of events, sourced from a meta-event tracking the transaction intent. (As a meta-point, I find it much more useful to think of the "graph" in accounting as having edges not made of money, but of data in a derived-event hierarchy.)
And a first step towards being able to have that mental model is ensuring that you have a good mental model of multiple physical-human actors accumulating events in a structured and atomic way.
But the OP doesn't actually make it clear that this is what the analogy is in service of! And I fear that the OP article will cause more confusion than it solves.
Unfortunately, QuickBooks won't help you understand accounting. It's not a true double-entry accounting system, at least it wasn't the last time I touched it. That said, it still does its job and does it well enough, and real accountants are fine with dealing with it.
Simply Accounting is a better example of a true double-entry system.
QuickBooks absolutely is a double-entry accounting system. The "bookkeeper" mode abstracts away and hides what's going on under the hood, but if you enter "accountant" mode, you'll see the full ledger, and you can even make direct journal entries to modify it.
I must have only ever encountered it in "bookkeeper mode". That abstraction is likely what threw me off!
I personally find the bookkeeper mode very confusing, and having observed others (non-accountants) using it to manage small businesses, I think that folks would be better off taking a one-day course in accounting and learning just enough to use it in accountant mode.
You don't have to be a CPA, just literally enough about A = L + E to follow the flow within Quickbooks and record one side of each entry.
Can you elaborate? I've used Quickbooks for over 15 years and it has always been a true double entry accounting system during that time.
>Double-entry, I suppose, means each event must be ingested exactly once by an even number of actors.)
No, the number of accounts (actors) does not have to be even. The sum of debits and credits has to be equal (or zero if you like).
You're right - it was a silly thing for me to write! Something more accurate would be that because debits and credits must balance, there is no way to send a message that would only be seen by a single account (other than a no-op); thus, any meaningful transaction will have an impact on at least two accounts.
Agreed.
anthropomorphizing the accounts is not the problem. the problem is that in the example the two parts of the double-entry are the two partners of the transaction. to anthropomorphize properly alice and bob would be two employees of the company buying a book from a bookstore.
i was about to write the same thing. knowing that double-entry is meant to apply to myself only, i actually found the example confusing, because well, of course bob is going to have an entry in his accounting book, but i don't care about bobs accounts, i don't want to track that. i only care about mine. i buy a book. how do i record this transaction using double entry bookkeeping in my accounting book?
and bob is not even doing any bookkeeping. he is bookselling ;-)
You gained $20 worth of assets, so the counterpart of the $20 leaving your bank account is countered by your assets-account gaining $20
Now each year your book loses 1/5th of its value, due to wear and tear (4$ disappearing from your assets-account), this is countered by your depreciation-account (4$ tax write off, every year!)
After 5 years, it is worth $0 according to your books, but you manage to sell it again for $10: your bank account gets debited for $10, while your capital-gains-account gets credited for $10
And how about food? I can understand a book having a resale value I keep in my books, but once I've eaten the hot-dog I bought it is gone forever.
Perishable and consumable food wouldn't be counted as an asset in the first place. You spend the money - it's credited to your asset account (reducing the value of your cash-in-hand) and then debited from your expense account (reducing the value of your equity - or, in more layperson's lingo, increasing the total sum of the expenses you incurred during that period).
Of course it would be, asset is anything of value, you're confusing with subtypes of assets. Just mujhe liability is anything you owe regardless of for how long
If an office buys snacks on Monday for the office party on Friday, they're not counting it as an asset and depreciating it on their books.
If food production or delivery were part of the core business, it would be one thing, but in the context that OP's talking about, it would be overkill at best (and fraudulent, in extreme cases) to try and count a transient consumable as an asset on their books.
Depreciation isn't relevant here, again, you're confused in the types of assets, not all of them are depreciated, only some with some specific properties like time of expected user. Just read the definition of assets in any (accounting) dictionary, or try to record your snack purchase in real accounts and see which side of the balance sheet this account end up in (hint: inventories, assets).
Yeah, and as I said, this makes sense for a company for which food is a relevant part of their business, but in the context OP is asking about, nobody is tracking it this way.
This is the best explanation, everyone else is giving wrong explanations that appear to be at least partially sourced from some AI.
I’m biased, but I hope my explanation[0] is more intuitive coming from a CPA.
[0]: https://www.winstoncooke.com/blog/a-basic-introduction-to-ac...