Double-entry book-keeping is the standard accounting practice for recording financial transactions. It was invented by Luca Pacioli, a close friend of Leonardo da Vinci.
The system is based on the concept that every transaction has a 'dual effect.' This is illustrated below.
Buying an asset;
- Effect 1; The volume of fixed assets in the business increases.
- Effect 2; The level of cash is reduced.
Selling stock on credit;
- Effect 1; The number of trade debtors for the business increases.
- Effect 2; The level of stock is reduced.
Paying a trade creditor;
- Effect 1; The number of creditors for the business is reduced.
- Effect 2; The amount of cash in the business is reduced.
For each transaction there will be a debit and a credit. An increase in any of the following will result in a debit:
- Debtors: entities who owe you money
An increase in any of the following will result in a credit:
- Creditors: entities who you owe money
An increase in a 'debit item,' must be accompanied by either an increase in a credit item, or a decrease in another debit item.
An increase in a credit item must be accompanied by either an increase in a debit item or a decrease in another credit item.
Credit and debit items are later summarised in a balance sheet and a profit and loss account.