You must first understand, or accept the first main principle of double entry bookkeeping before we start, and this applies equally to making them in your accounting software or wether you are making them in a book by hand, and that is –

For every entry made there must be an equal and opposite entry made somewhere else and when you have finished making your entries they must all add up to zero. Don't worry most packages will make most of these day to day entries for you.

Sounds weird - not really. The whole principal is logical and goes back to the days when all books where done manually and by making all of the entries add up to zero we knew we had correctly entered our numbers. We may not have entered them into the right slot but at least we had created the basis of being on the right track.

Even though your accounting software will, in most cases, make most of the entries for you, you must understand the principle behind it.

We mentioned above that every entry needs an equal and opposite entry somewhere else so lets use sales as the beginning of our understanding of this concept.

We sell a product, or service to Bill Brown for $100.00. Now it is quite easy to understand that this gives us a credit of $100.00 to our business but we also need to create an equal and opposite entry somewhere else so if we took the $100 and put it in the bank we would debit the bank account in the accounting software ledger.

In most cases one side of the entry would go to the Profit and Loss Section and the other to the Balance Sheet section. The dividing line between the two is often called the BOTTOM LINE and the last account in the Profit and Loss section will be called NET PROFIT

I know you might be thinking that that is a lot of baloney because when we look at our bank statement we see that the money we have deposited is shown as a credit.

Quite correct but we are talking about a double entry bookkeeping system here and not bank statements. We debit money into the bank.

The entries would look like -

Sales Account (Profit & Loss) 100.00 Credit
Bank Account (Balance Sheet) 100.00 Debit

If we add these two entries together they will add up to zero. We have fulfilled the basic criteria of equal and opposite entries as well as them adding to zero.

You'll also note that one side is to the Profit and Loss section and the other to the Balance Sheet section.

As many of our sales could be to people that have an account with us and therefore owe us (Trade Debtors). Let's assume that Bill Brown is one of those - therefore the entries would look like -

Sales Account (Profit & Loss) 100.00 Credit
Trade Debtors (Balance Sheet)100.00 Debit

(Trade Debtors - people that owe us money)

Again, the criteria have been met.

So far we have looked at a simple transaction where one of the entries, Sales, went into the profit and Loss and the other into the Balance Sheet, Bank or Trade Debtors. Both the bank and trade debtors are asset accounts.

Remember we talked about the Bottom Line earlier well you could say that one of the entries went above the bottom line (into the Profit and Loss section) and the other below the bottom line (into the Balance Sheet section)

In either of the above examples if you are using a sales module in your accounting software then the accounting software should make both ledger entries for you automatically.

Where an entry goes above the line and its equal and opposite entry goes below the line the transaction typically affects your net wealth. In the example if the $100.00 sale was for a service we offered and had no cost attached to it then we have increased our wealth by $100.00.

There is another set of transactions that don't affect our wealth or in fact change it at all.

Let's assume that some time later Bill Brown pays us the $100.00 he owes us. What happens now?

Originallythe accounting software made the opposite entry to sales as a debit to the trade debtor's account in the ledger. So we currently have a $100.00 debit in our asset account (trade debtors-people owing us money).

When the cheque arrives from Bill Brown we need to transfer the $100.00 from the trade debtor's account in the ledger to the bank account in the accounting software's ledger.

Originally the accounting software debited Trade debtors to get the money into the account so now we have to credit that account and make an equal and opposite entry to the bank account in the ledger.

The entries would therefore look like -

Trade Debtors (Balance Sheet) 100.00 Credit Bank Account (Balance Sheet) 100.00 Debit

(Trade Debtors - people that owe us money)

So, both of these entries are below the line in the balance sheet. Both are asset accounts - The bank account and the trade debtor's account.

When the accounting software made the entry when we received Bill's cheque we actually didn't change our net wealth in any way.

The total of our assets didn't change in any way either. We simply transformed one asset type into another. (someone owing us money to cash in the bank) Same difference, except we now have the actual cash in our possession instead of someone owing us.

Again your accounting software should have made all of the entries for you into the general ledger, initially when you enter the customers purchase by way of doing a sales invoice to the customer and then when you enter the customer's payment into the accounting software.

Let's look at what happens when you make a purchase -

You buy some office stationery for $100.00 and pay by cheque. We can easily accept that we have created a debit to our business for $100.00. So how would the entries look -

Stationery Account (Profit & Loss) 100.00 Debit Bank Account (Balance Sheet)100.00 Credit

From this we see that one of the entries is above the line into the Profit and Loss (stationery) and one of the entries is below the line into the Balance Sheet (bank). We have also reduced our wealth by the $100.00 above the line transaction.

If we bought the stationery on account we would then see that the accounting software has made the following entries -

Stationery Account (Profit & Loss) 100.00 Debit Trade Creditors (Balance Sheet) 100.00 Credit

(Trade Creditors - people we owe money to)

When we finally paid the stationery company we would see the accounting software has made the following entries -

Trade Creditors (Balance Sheet) 100.00 Debit Bank Account (Balance Sheet)100.00 Credit

Again this last entry has not changed our net wealth in any way. Both entries are below the line in the balance sheet. We have simply changed our asset form. We have got rid of a liability to our business of $100.00 but, at the same time we have $100.00 less in the bank. The net result is the same.

Once again the accounting software should have made all of the ledger entries for you automatically. Firstly when you entered the suppliers invoice into the payables module and then when you entered the payment to the supplier - also in the payables module.

When we enter supplier invoices into the system for goods or services that we have purchased it is common for one side of the entry to go to the Profit and Loss section and for the other to go to the Balance Sheet section. For example - Stationery - the first side is a debit to the stationery account in the Profit and Loss, the second side is either to the Bank or Trade Creditors in the Balance Sheet section. There is one big exception to this and that is if we are buying goods that we are going to resell.

When goods are purchased for resale we are not changing our wealth in any way - our net asset value doesn't change either.

We buy $100.00 for resale. This will increase the value of the Stock on Hand account in the Assets section of the Balance Sheet by $100.00 This is then, either put onto our account with the supplier and therefore adds $100.00 to our Trade Creditors account in the Liabilities, or we pay for it out of the Bank Account in the Assets section.

Just to reinforce the principle again - we debit asset accounts to increase their value and credit them to decrease their value - we credit asset accounts to increase their value and debit them to decrease their value.

I have been involved in all aspects of the accounting software industry for over 20 years. I run several websites that specialize in various subjects including http://www.diyaccounts.com.au that gives advice on all aspects of accounting software from choosing, setting up and using it. Amongst other sites that I run are http://www.sense-now.com that helps newbies understand what internet business will probably work for them and what won’t. http://www.oumas.com.au is all about arts, crafts, hobbies, wine and beer making and much more.

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