Understanding Double-Entry Bookkeeping and The Accounting Equation

Key Takeaways

There are two methods of recording financial transactions in the accounting system: Single-entry Bookkeeping and Double-entry Bookkeeping.
The Accounting Equation is the most basic concept in accounting that serves as the foundation of the double-entry bookkeeping system. This equation is presented as Assets = Liabilities + Equity.
The accounting equation shows assets on the left side of the equation while liabilities and equity appear on the right side. Both sides must maintain their equilibrium at all times even if there are changes in the amounts of each element in the equation.

Single-entry Bookkeeping

Accounting keeps track of a company’s financial position and performance by recording all financial transactions that have occurred during an accounting period. The two accounting methods of recording financial transactions are the Single-entry Bookkeeping and the Double-entry Bookkeeping.

What is single-entry bookkeeping?

Under the Single-entry Bookkeeping system, only one entry is recorded in the journal for every transaction.

The Single-entry Bookkeeping method is a simple and straightforward way of recording financial transactions that revolves around the cash account of the business only. This method can be used by very small businesses that do not need to prepare financial statements for third party stakeholders.

For many small businesses, only the cash account is monitored because most of their sale and purchase transactions involve only cash and that there are no sales and purchases on account.

To better understand the single-entry bookkeeping method, let’s assume that on April 1, 2025, you started a consulting business. The following sequence of transactions occurred in your business during your first month of business:

April 1 – you invested $1,000 cash as initial capital.
April 5 – you spent $250 for renovation costs of your home office.
April 6 – you purchased $50 worth of office supplies.
April 14 – a client paid $500 for consultation services.
April 17 – you purchased a set work table and chairs amounting to $300.
April 25 – another client paid you $500 for consultation.
April 30 – you paid $300 for electricity and water used by your business.

The above transactions will be recorded in the cash book as follows:

Given its name, the cash book above consists of cash transactions only. Since only one entry is made using the single-entry bookkeeping method, no other entries will be recorded for separate accounts such as revenue and expenses.

Using the single-entry bookkeeping method will always result in an accounting equation that is not balanced because only one aspect of the transaction is recorded. As you’ll learn later, the accounting equation should always maintain its balance by having each side of the equation equal with each other.

Double-entry Bookkeeping

What is double-entry bookkeeping?

Under Double-entry Bookkeeping, recording a transaction involves at least two accounts that will result in a two-sided entry in the journal.

The Double-entry Bookkeeping method of recording transactions already existed way back during the Italian Renaissance when the Italian city-states of Genoa, Florence and Venice experienced economic prosperity due to the rise of commerce in these areas. Father Luca Pacioli documented the double-entry bookkeeping method in his book Summa de Arithmetica, Geometria, Proportioni et Proportionalita.

Most businesses, small or large, use double-entry bookkeeping since this method makes it possible to prepare a company’s financial statements. This method allows you to prepare accurate financial statements that are in accordance with established accounting standards.

Double-entry bookkeeping doesn’t mean that transactions are entered twice in the journal. It only implies that both sides of a transaction are entered where one account is debited and another one is credited. This results in equal but opposing entries in both accounts.

Debit and credit entries are used for the two halves of each transaction. For every debit element, there is always a corresponding credit element. Both elements should have equal amounts in order to maintain balance in the basic accounting equation.

You may find the concept of double-entry bookkeeping a bit confusing. But this method will begin to make sense once we discuss about the accounting equation later.

One advantage of the double-entry bookkeeping method is that it allows recording of transactions that involve statement of financial position (balance sheet) items and income statement items at the same time. For starters, the statement of financial position and the income statement are one of the financial statements that are regularly prepared by most businesses.

Let’s assume that you’re a provider of apartment cleaning services and one of your clients paid you for your services. To record this transaction, a debit to the Cash account and a credit to Service Revenue will be entered in the journal simultaneously. Cash is an account that appears in the statement of financial position while service revenue is an income statement account.

In the above example, notice that the transaction has corresponding debits and credits. The cash account was debited while the service revenue account was credited. Both the debit and credit entries increased the two accounts.

Let’s have another example. Assume that your business was charged on account by a utility company for the amount of electricity and water that your business has consumed during the month. An entry to record this transaction consists of a debit to Utilities Expense and a credit to Accounts Payable simultaneously. Utilities expense is an income statement account while accounts payable is a statement of financial position account.

In both examples, you’ll notice the connections between the two financial statements. One side of every revenue and expense-related transaction entry will always affect a statement of financial position account while another side will affect the income statement.

The Basic Accounting Equation

What is the accounting equation?

The Accounting Equation, also known as the Balance Sheet Equation, is the most fundamental accounting concept. It is a basic tool used by accountants to record and analyze the financial transactions of a business.

The accounting equation is a concept that serves as the foundation of the double-entry bookkeeping method. Under this system, every transaction that you’ll record in the accounting books will result in two entries, i.e. a debit entry equal to a credit entry. Both entries should have equal amounts in order to maintain the balance in the accounting equation.

The accounting equation presents the statement of financial position elements of assets, liabilities and equity and how each element relate with one another. But what are assets, liabilities and equity?

Assets are economic resources controlled by the business as a result of past events and from which future economic benefits are expected to flow to the company. Examples of assets are cash, merchandise inventories, accounts receivable, short-term investments, fixed assets, long-term investments, and intangible assets.
Liabilities are present obligations of the business arising from past events, the settlement of which are expected to result in outflows from the company of resources embodying economic benefits. Examples of liabilities are accounts payable, notes payable, tax payable, warranty liability, mortgage payable, and bonds payable.
Equity is the residual interest in the assets of the entity after deducting all of its liabilities. Examples of equity accounts are owner’s capital, partner’s capital, share capital, share premium, retained earnings, and treasury shares.

The accounting equation shows assets on the left side of the equation while liabilities and equity appear on the right side. Both sides must be equal at all times, and this equilibrium should be maintained even if there are changes in the amounts of each element from both sides.

Assets are equal to the combined sum of the company’s liabilities and equity. This means that the assets of a company are claimable by both the creditors and owners of the business.

It is important to note that liabilities are presented first before equity in the accounting equation since creditors and lenders have preferential claims over the assets of the business. In case the business closes down, its assets will be distributed to creditors first as settlement for the company’s obligations. Any remaining assets after all liabilities have been paid will be distributed to the owners of the business.

Equity, which is also referred to as Net Assets, is the amount that is due and can be distributed to the owners of the company. It can be emphasized using the formula:

If the company has no liabilities, the formula will only consist of assets and equity as follows:

Let’s illustrate below how the accounting equation works.

On January 1, 2023, Mr. A opened Moments and Memoirs, a video production company that specializes in wedding video coverage. Below are the initial transactions that he made prior to starting his business operations:

Mr. A invested $50,000 as initial capital for his business.
He purchased all the necessary equipment for audio, lighting, video, editing, and storage amounting to $30,000 out of the cash he invested in the business.
Mr. A purchased a vehicle that he and his crew will use for the business. The purchase amounted to $40,000 where $10,000 down payment was made. Mr. A issued a promissory note for the remaining balance.
He purchased office supplies amounting to $1,000.
Mr. A withdrew $500 cash for personal use.

Below is an analysis of each transaction and its effect in the accounting equation.

Transaction 1 – the initial capital investment of $50,000 increases the cash account, an asset, with a corresponding increase of the same amount in Mr. A’s capital account.

Transaction 2 – the value of one asset account, equipment, increased by $30,000 while the cash account decreased by the same amount. The accounts impacted in this transaction are both asset accounts, therefore only the left side of the accounting equation was affected. However, the equation remains balanced because the increase in value of one asset account has a corresponding decrease of the same amount in another asset account, both of which are located the same side of the equation.

Transaction 3 – the purchase of a vehicle amounting to $40,000 affected both the asset and liability side of the equation. First, the vehicle account, which is an asset, increased by $40,000. Second, the cash account, which is another asset, decreased by $10,000 because of the down payment. Third, the notes payable account, which is a liability increased by $30,000, which is equal to the remaining balance after deducting the down payment. The effect of this transaction was a net increase of $30,000 on the asset or left side of the equation and a corresponding increase of the same amount on the liabilities or right side of the equation. Note that both sides of the equation are still balanced.

Transaction 4 – this is similar to the second transaction where only the left side of the accounting equation was affected since only asset accounts were involved – prepaid supplies increased and cash decreased by $1,000.

Transaction 5 – the withdrawal of cash for personal use decreased the cash account by $500 with a corresponding decrease in the owner’s capital account by the same amount. Withdrawal of assets from the business by the owner for personal use reduces owner’s equity.

Observe that in all of the transactions above, the equilibrium of the accounting equation was maintained even if the transaction affected only one side of the equation.

Below is the statement of financial position of Moments and Memoirs after accounting for the above transactions.

The statement of financial position above is presented in a form that follows the format of the accounting equation. This financial statement can be viewed as the formal presentation of the accounting equation because it also presents the assets first and then followed by liabilities and equity.

In our example above, the following rules in double-entry bookkeeping were observed:

Every transaction must have an equal amount of debit entry and credit entry, regardless of the number of accounts affected.
The total change in asset amounts should always equal the total change in liability and equity amounts to maintain the equilibrium of both sides of the accounting equation.

If the single-entry bookkeeping method was used in the example above, the two sides of the accounting equation will not be equal and the accounting records will not be complete because only one aspect of the transaction was recorded. That’s why double-entry bookkeeping is always the preferred method since it results in more accurate accounting records.

The Expanded Accounting Equation

The accounting equation can be expanded by integrating the effects of revenue and expense to the owner’s equity.

Under the expanded accounting equation, the transactions that affect equity are as follows:

Owner investments and revenue that increase equity
Owner withdrawals and expenses that decrease equity.

Net Income

The Income Statement is another financial statement that presents the financial performance of the company over a specified period of time. The two main elements of the income statement are income and expenses. Both are used to determine if the operating performance of the company generated a profit or a loss.

A Net Income or Net Profit is a favorable outcome which is achieved when the total amount of income earned exceeds the total amount of expenses incurred by the business. It helps a company sustain and expand its operations.

On the other hand, when the total amount of expenses incurred are greater than the total amount of income earned, the company suffers a Net Loss during the period covered by the income statement. Not producing profits over time could eventually push a business into bankruptcy and closure.

The table below shows the effects of income and expenses in the accounting equation:

Based on the above table, income and expenses have an effect on each of the accounting equation elements as follows:

Income increases both assets and equity.
Income decreases liability and increases equity
Expense decreases both assets and equity
Expense increases liability and decreases equity

Let’s continue with the example above for Moments and Memoirs’ first month of operations.

Below are the transactions of the business during January 2023:

January 3 – paid $300 for minor office repairs.
January 5 – paid business registration fees amounting to $500.
January 7 – paid $1,000 in social media advertisements.
January 20 – paid $400 for gasoline expenses.
January 29 – paid one month office space rent amounting to $600. Expenses for water, electricity and internet amounted to $400 and will be paid on the following month.
January 31 – during the month, the business was able to acquire three clients and collected a total revenue of $3,000. Paid salaries for one videographer and one editor amounted to $1,600.

The effects of these transactions are summarized in the table below:

Notice that the equilibrium of the accounting equation was still maintained throughout the first month of operations.

Below are the income statement and the statement of financial position of Moments and Memoirs for the period January 1 to 31, 2025.

Note that the revenues and expenses in the income statement was already incorporated to the owner’s capital account in the equity section of the statement of financial position. The reason for this is that these temporary accounts in the income statement are permanently closed or transferred to the owner’s equity in the statement of financial position at the end of the accounting period.

Review Questions

What is the accounting equation?
Why are assets located on the left side of the accounting equation while both liabilities and equity are shown on the right side?
How do income and expenses affect the accounting equation?
What is the main difference between single-entry bookkeeping and double-entry bookkeeping?
Why does the single-entry bookkeeping method lead to an unbalanced accounting equation?