Explaining Double-Entry System for Non-Accountants

Financial accounting might seem like a complex world filled with specialized terminology. However, at its core, accounting is based on a simple yet powerful principle called the double-entry system. For non-accountants, this article will simplify the double-entry system, explaining it in a clear and easy-to-understand manner, with a focus on practical examples to clarify the concept and remove any ambiguity.

What is the Double-Entry System for Non-Accountants?

Simply put, the double-entry system for non-accountants means that every financial transaction has an effect on at least two accounts, one increasing and the other decreasing by the same amount. Imagine a balance scale with two pans. The pans must always remain balanced. When you add something to one pan, you must either add the same weight to the other pan or remove the same weight from the first pan to maintain equilibrium.

In the world of accounting, these two sides are:

• Debit (Dr.): The side that “receives” or “increases” in the financial transaction.
• Credit (Cr.): The side that “gives” or “decreases” in the financial transaction.

The Source of Simplicity and Complexity: The simplicity in understanding the double-entry system for non-accountants comes from its analogy to a balance scale – every financial transaction must be recorded on two equal sides. The complexity, however, arises from determining which side is the debit and which side is the credit, which we will explain in detail later.

Simple Example: Imagine you bought a new phone for 500 Riyals in cash. In this transaction:

• Your assets (the phone) increased by 500 Riyals (Debit side).
• Your cash decreased by 500 Riyals (Credit side).

Thus, the transaction is recorded on two equal (500 Riyals) and opposite (increase and decrease) sides.

Why Use the Double-Entry System for Non-Accountants?

You might wonder, why all this complexity? Why not just record what increased or decreased and be done with it? The answer lies in the fact that the Double-Entry System for Non-Accountants provides several important benefits, such as:

• Accuracy: This system helps record financial transactions accurately, as any error on one side will lead to an imbalance in the entry, making it easier to detect and correct.
• Completeness: The double-entry system provides a complete picture of the financial transaction, recording all its aspects and effects.
• Control: This system facilitates the review of accounts and verification of the accuracy of financial data, both internally and externally.
• Analysis: The double-entry system enables the analysis of financial data and the extraction of useful information about the entity’s performance and financial position, which helps in making better decisions.
• Fraud Prevention: It is difficult to manipulate accounts when using the double-entry system because any manipulation on one side will lead to an imbalance in the accounting equation.

The Accounting Equation: The Secret to Balance

The Double-Entry System for Non-Accountants is based on a fundamental equation called the “accounting equation,” which is:

Assets = Liabilities + Equity

• Assets: Everything you or your company owns that has value, such as cash, buildings, cars, goods, and customer accounts.
• Liabilities: The debts you or your company owe to others, such as loans from banks or money owed to suppliers.
• Equity: What remains of the assets after liabilities are paid, representing the investments of the company’s owners or its retained earnings.

The double-entry system ensures that this equation remains balanced at all times. Any change on one side of the equation must be matched by an equal and opposite change on the other side.

How to Understand the Double-Entry System Easily (For Non-Accountants)

To understand the double-entry system, you need to think about each financial transaction from two perspectives:

1. What did you receive (or what increased)? (This will be the debit side).
2. What did you give (or what decreased) in return? (This will be the credit side).

Nature of Accounts and Their Impact on Entries

To understand which side of a financial transaction is the debit and which is the credit, you need to know the nature of each account:

• Assets: Normally have a debit balance. An increase is recorded on the debit side, and a decrease is recorded on the credit side.
• Liabilities: Normally have a credit balance. An increase is recorded on the credit side, and a decrease is recorded on the debit side.
• Equity: Normally has a credit balance. An increase is recorded on the credit side, and a decrease is recorded on the debit side.
• Revenues: Normally have a credit balance. An increase is recorded on the credit side, and a decrease is recorded on the debit side.
• Expenses: Normally have a debit balance. An increase is recorded on the debit side, and a decrease is recorded on the credit side.

Summary Table of Account Natures:

Practical Examples to Illustrate the Double-Entry System for Non-Accountants

1. Purchase of Office Furniture for 2000 Riyals in Cash:
   • What did you receive? Furniture (increase in assets – an asset is normally debit).
   • What did you give? Cash (decrease in assets – an asset is normally debit).
   • Entry:
     • 2000 Riyals (Debit) – Furniture
     • 2000 Riyals (Credit) – Cash
2. Providing a Service to a Customer for 3000 Riyals, Receiving Half in Cash and the Rest on Account:
   • What did you receive? Cash (increase in assets) and a promise of payment from the customer (increase in assets – accounts receivable).
   • What did you give? Service (increase in revenues – revenue is normally credit).
   • Entry:
     • 1500 Riyals (Debit) – Cash
     • 1500 Riyals (Debit) – Accounts Receivable
     • 3000 Riyals (Credit) – Revenue
3. Paying 500 Riyals Towards a Bank Loan:
   • What did you receive? Nothing tangible, but you reduced your debts (decrease in liabilities – a liability is normally credit).
   • What did you give? Cash (decrease in assets).
   • Entry:
     • 500 Riyals (Debit) – Loan Payable
     • 500 Riyals (Credit) – Cash
4. The Company Owner Deposits 10,000 Riyals of Personal Funds into the Company Account:
   • What did the company receive? Cash (increase in assets).
   • What did the company give? Nothing tangible, but the owner’s equity increased (increase in equity – equity is normally credit).
   • Entry:
     • 10,000 Riyals (Debit) – Cash
     • 10,000 Riyals (Credit) – Owner’s Capital
5. Paying a 300 Riyal Electricity Bill:
   • What did you receive? Electricity service (increase in expenses – an expense is normally debit).
   • What did you give? Cash (decrease in assets).
   • Entry:
     • 300 Riyals (Debit) – Electricity Expense
     • 300 Riyals (Credit) – Cash
6. Purchasing Goods from a Supplier for 6,000 Riyals on Account:
   • What did the entity receive? Goods/Inventory (Increase in Assets).
   • What did the entity give? Nothing yet, but incurred a liability to the supplier (Increase in Liabilities).
   • Entry:
     • 6,000 Riyals (Debit) – Purchases/Inventory
     • 6,000 Riyals (Credit) – Accounts Payable/Supplier
7. Selling Goods for 8,000 Riyals, with a Cost of 5,000 Riyals, in Cash:In this case two journal entries will be made. One to record the Cost of Goods sold, another to record the actual sale.
   • Entry 1 (Cost of Goods Sold):
     • What did the entity receive? Nothing Tangible, but the goods held decreased (Decrease in Asset)
     • What did the entity give? Nothing Tangible, but Cost of Goods Sold increased (Increase in Expense)
     • Entry:
       • 5,000 Riyals (Debit) – Cost of Goods Sold
       • 5,000 Riyals (Credit) – Inventory/Goods
   • Entry 2 (Recording the Sale):
   • What did the entity receive? Cash (Increase in Asset)
   • What did the entity give? Nothing Tangible, but increased its revenue (Increase in Revenue).
   • Entry:
     • 8,000 Riyals (Debit) – Cash
     • 8,000 Riyals (Credit) – Sales Revenue

Important Note: Account names may vary from one company to another, but the fundamental principle of the double-entry system remains constant.

Journal and Ledger: Tools for Recording and Posting Entries

• Journal: A chronological record where all the company’s financial transactions are recorded day by day, showing the debit and credit sides of each transaction. The journal is like a diary where you record all financial events in the order they occur.
• Ledger: A book containing separate accounts for each element of assets, liabilities, equity, revenues, and expenses. Each side of the entries recorded in the journal is posted (transferred) to its respective account in the ledger. The ledger is like separate files where you gather all the information related to a specific account, such as the cash account, accounts receivable, or sales account.

The Double-Entry System and Financial Statements: The double entry system is the base to prepare the financial statements, which provide a summary of a company’s performance and position over a certain period.

• Income Statement: Summarises a company’s revenue and expenses over a period, this is prepared from the debit and credit balances of revenue and expense accounts.
• Statement of Financial Position (Balance Sheet): Summarises a company’s assets, liabilities and equity at a point in time. Prepared using the debit and credit balances for asset, liability and equity accounts

Common Mistakes in Applying the Double-Entry System for Non-Accountants:

• Reversing the Entry: Recording the debit side on the credit side and the credit side on the debit side.
• Unbalanced Entry: Recording different amounts on the debit and credit sides.
• Recording the Entry in the Wrong Account: Recording the financial transaction in an unrelated account.
• Failing to Record One Side of the Entry: Forgetting to record one side of the financial transaction.

Tips for Understanding the Double-Entry System for Non-Accountants:

• Start by understanding the accounting equation.
• Learn the nature of debit and credit accounts.
• Practice recording financial transactions using the double-entry system through practical examples.
• Use educational resources available online, such as websites and educational videos.
• Do not hesitate to ask a professional accountant if you encounter any difficulty.
• Use Simplified Accounting Software: Accounting software makes it easy to record financial transactions without needing in-depth knowledge of the double-entry system.

Conclusion: Mastering Double-Entry Simplifies Understanding the World of Finance

TheDouble-Entry System for Non-Accountants might seem complex at first, but with the right understanding and practice with examples, it will become clear and easy to apply. Remember that this rule is the foundation upon which all accounting operations are based. Mastering it will help you understand the world of finance and business better, even if you are not a professional accountant. Knowing the basics of the double-entry system enables you to read simple financial reports and understand how financial transactions are recorded, which enhances your financial literacy and helps you make wiser personal financial decisions and better understand the situations of companies.