Double entry bookkeeping refers to the accounting concept whereby each transaction affects both the income statement and balance sheet. For example, say that Nike sells a pair of shoes. This sales impacts its income statement since NIke now has higher revenue. This sales impacts its balance sheet since Nike now has more cash (in “Assets”).
Likewise, the same happens when Nike purchases raw materials from its suppliers. It’s COGS or expenses will increase in the income statement and Nike’s account payable in its balance sheet may increase if its purchasing raw materials on credits.
What does it mean to balance credits with debits?
You’ve probably heard of the saying that the balance sheet must be balanced. More specifically, the assets must be equal to the company’s liabilities plus equity. This can happen because of double entry bookkeeping and how the three financial statements are linked to one another.
Each accounting entry has a debit and credit which affect the three financial statements. Asset accounts like your company’s bank account increases in value when there’s a debit and decreases when there’s a credit. This is the inverse for liability and equity accounts.
This is one of the reasons why double entry bookkeeping is still used. Your balance sheet being balanced is a sign that your accounting is done properly. While there’s now accounting software like Xero and Quickbooks, it’s always good to have another signal that can tell you if accounting is done right.
