If you are going into business, you’ll need an accountant to set up your books and a bookkeeper to gather and record your financial data. Businesses record their transactions by the double-entry bookkeeping process.
Double-entry bookkeeping is based on an equation which states that a business’s assets (cash, accounts receivable, inventory, real estate, and equipment) minus its liabilities (any amounts owed to suppliers and other creditors) equals proprietorship (the company’s worth to its owners). Income increases proprietorship, expenses decrease it. Every business transaction affects more than one component of the equation but in such a way that the two sides always balance. A sale of goods for cash increases an asset (cash) and proprietorship (income). Payment of a loan in cash decreases an asset (cash) and a liability (loans payable). In both cases, the balance of the equation is unaffected.
Business transactions are recorded in five basic types of accounts: asset, liability, proprietorship, income, and expense. These accounts, which may be subdivided, are contained in a book called the general ledger. Debits and credits Each ledger page contains information on one account only. A page is divided into a left, or debit, side and a right, or credit, side. (In bookkeeping, the terms debit and credit refer only to the left and right sides of a ledger page.) Increases and decreases in an account are entered on opposite sides of a page. Increases in assets and expenses are entered on the debit side; increases in liability, proprietorship, and income on the credit side. Thus, payment of a loan in cash is credited to cash (an asset decrease) and debited to loans payable (a liability decrease). The difference between total credits and debits in one account at the end of a bookkeeping period is called the balance-a credit balance if credits are greater; a debit balance if debits are greater.
For every debit entry in one account there must be a corresponding and equal credit entry in another; hence
the term double-entry bookkeeping.
Total debits in all accounts in the ledger must always equal total credits. Similarly, the sum of debit balances in the ledger must always equal the sum of credit balances. If they don’t, the records contain an error that must be found and corrected.