Double-Entry Accounting Simply Explained

Proper accounting is an essential aspect of running a company effectively. Most businesses are required to follow the principles of double-entry accounting while preparing their accounts. Double-entry accounting is a fundamental concept in modern accounting practices.

It is a system of accounting in which every financial transaction is recorded in two different accounts, a debit account and a credit account. This article provides a simple explanation of double-entry accounting in Switzerland.

What is Double Entry Accounting?

Double-entry accounting is a method of bookkeeping that records every financial transaction in at least two different accounts (hence the name “double-entry”), with one account debited and another offsetting account credited. The sum of all debits must equal the sum of all credits, ensuring that the accounting equation (Assets = Liabilities + Equity) is always balanced.

The double-entry accounting process helps to accurately document the success or failure of a business during the accounting period in question. It reflects the current situation and profitability of the business through financial statements such as the balance sheet and the income statement.

What do the terms “debit” and “credit” mean?

In accounting, the terms “debit” and “credit” are used to record transactions. Debit refers to an increase in assets or a decrease in liabilities or equity, while credit refers to a decrease in assets or an increase in liabilities or equity. Accounts are referred to as either “debit accounts” or “credit accounts”. A debit account is one where an increase in its value is recorded on the debit side and a decrease on the credit side, and vice versa for a credit account.

It is interesting to note that the debit side is always on the left and the credit side is always on the right of the accounting books. This is common throughout the accounting world. The credit account is also sometimes called the “offset account”.

Single Entry Accounting vs Double Entry Accounting

While double-entry accounting is the most precise and generally preferred method for keeping track of a company’s books, there are other methods which are also used. These are referred to as single-entry accounting methods, or “simplified bookkeeping”.

Simplified Bookkeeping

Simplified bookkeeping is an easier method of accounting whereby transactions are recorded in a cash book, which is a simple record of all cash receipts and payments. The transactions are placed in broad categories such as income and expenses, and recorded in chronological order. The advantage of simplified bookkeeping is that it is easier to understand and implement, which makes it well-suited to smaller businesses and individuals. However, it lacks the accuracy and completeness of double-entry accounting.

Double-entry Accounting

Double-entry accounting, on the other hand, records each financial transaction in two accounts: the account where the inflow or outflow actually took place (e.g., cash account) as well as what the money was used/received for (e.g., inventory purchase, sales, etc.). This ensures that every transaction is properly accounted for and that the accounting equation always remains balanced. This system of accounting is more complex than single-entry accounting, but it provides a more accurate and complete picture of a company’s financial situation.

Do All Companies Have to Keep Double-Entry Accounting?

Most Swiss companies are legally required to use double-entry accounting methods, but not all. According to the Swiss Code of Obligations (CO), the requirements are as follows:

• Companies which are separate legal entities are obliged to use double-entry bookkeeping. This includes all stock corporations (AGs) and limited liability companies (GmbHs).
• All companies with an annual turnover of at least CHF 500,000 are obliged to use double-entry bookkeeping. This includes sole proprietorships and partnerships.

(CO Article 957).

What this basically means is that sole proprietors and partnerships with an annual turnover of less than CHF 500,000 may use simplified bookkeeping methods such as single-entry bookkeeping if they so choose. However, even these companies can benefit from the greater precision of double-entry accounting and so are recommended to use it if they have the resources and expertise to do so.

How Does Double-Entry Accounting Work in Practice?

Double-entry bookkeeping involves the following steps:

1. Identify the financial transaction: Whenever a financial transaction takes place, such as a sale, purchase, or payment, the transaction is identified and recorded.
2. Determine the accounts involved: The accounts affected by the transaction are determined according to the chart of accounts. These can be, for example, asset accounts or liability accounts in the balance sheet, or expense accounts and income accounts in the income statement.
3. Record the transaction: The transaction is recorded by making entries in the appropriate accounts. In the case of one account, the entry takes place on the debit side, and in the case of the contra account, on the credit side.
4. Ensure the accounts are balanced: The total amount of debits must always be equal to the total amount of credits. If there is a discrepancy, the accounts must be reviewed to identify and correct any errors.

Swiss Accounting Standards

Companies throughout the world will usually prepare their accounts according to a specific industry-wide set of accounting standards, also called a “chart of accounts”. In Switzerland, mainly the ”Code of Obligations” (CO), the “Swiss Generally Accepted Accounting Principles” (Swiss GAAP FER) or the “International Financial Reporting Standards” (IFRS) are followed.

Swiss GAAP FER is a set of accounting standards that provide detailed guidelines for the preparation of financial statements in Switzerland, including the balance sheet, income statement and cash flow statement. IFRS are widely used accounting standards that are generally followed throughout Europe and many other parts of the world.

Both accounting standards, Swiss GAAP FER and IFRS, pursue the goal of achieving the greatest possible transparency of material facts and follow comparable general standards, such as the “true and fair view” in the case of IFRS or the FER standard, according to which the annual financial statements must give a true and fair view of the company’s net assets, financial position and results of operations.

Why double-entry bookkeeping?

Double-entry bookkeeping is more complex, costly, and time-consuming than single-entry. So, the question may arise, why go through the extra trouble of using double-entry accounting practices?

Double-entry bookkeeping is, in fact, an incredibly useful tool which can contribute to the overall success of a business. Sound double-entry accounting practices can help provide valuable insights into the company’s financial situation and therefore aid in making informed financial and operational decisions. Let’s explore some of the advantages of double-entry accounting:

Benefits of double-entry accounting:

1. More information leads to better decision-making: Whereas simplified bookkeeping approaches only keep track of income and expenditure, double-entry accounting provides a much more comprehensive picture. For example, you will be able to keep track of exactly how much money has been spent for specific purposes, how much inventory and cash you have at your disposal, and the value of your assets and liabilities at any given time. You will have a complete understanding of the company’s overall financial situation and profitability. This additional information will help identify opportunities and risks and ultimately enable you to make better decisions about the company’s operations and plans.
2. Accuracy: Double-entry accounting ensures accuracy in financial records by requiring every transaction to be recorded in at least two accounts. When the books are finalised and posted, the total of the credit side of the ledger should equal the debit side, as well as other inbuilt crosschecks inherent in the double-entry method. This helps to reduce errors and discrepancies in financial statements and provides a more reliable picture of a company’s financial situation.
3. Transparency:Double-entry accounting provides a clear and transparent picture of a company’s financial situation. It also helps in generating key metrics, such as cash-flow, liquidity, P/E and D/E ratios, etc. This makes it easier for stakeholders to understand the overall financial health and success of the business.
4. Compliance: Double-entry accounting is a widely accepted method of bookkeeping and is a basic regulatory requirement for corporate entities in Switzerland and many other countries. Accurate and complete financial records are essential for tax reporting, financial audits, and other compliance requirements.

Features of Financial Accounting

Financial accounting deals with the preparation of financial statements, for both internal review and external stakeholders. Financial accounting has several key elements and features.

Types of Accounts

There are several types of accounts in accounting which can be generally separated into distinct categories. These include assets, liabilities, equity, revenue, and expenses. Assets are resources owned by the company, while liabilities represent obligations owed by the company, such as debt. Equity represents the owners’ residual interest in the company after liabilities are deducted from assets. Revenue represents the company’s earnings from its normal business activities, while expenses represent the costs of doing business.

Financial Statements

The aforementioned types of accounts are reflected in a company’s financial statements. Financial statements are a set of reports that provide information about a company’s financial position and performance. There are three main financial statements:

Balance Sheet

The balance sheet provides a snapshot of a company’s financial position at a specific point in time. It records the company’s assets, liabilities, and equity, and shows how they are related. The balance sheet is based on the accounting equation:

Assets = Liabilities + Equity

Assets:

Assets represent the resources that a company owns. They can be tangible, such as property and equipment, or intangible, such as patents and copyrights. They can also be short-term/current, such as inventory and cash, or long-term/fixed, such as land and buildings.

Liabilities:

Liabilities represent the obligations that a company owes to others. They can be current, such as accounts payable, or long-term, such as loans and bonds.

Equity:

Equity represents the owner’s interest in the business. It can be in the form of retained earnings, common stock, or other equity instruments.

Income Statement

The income statement shows a company’s revenues, expenses, and net income or loss over a specific period of time, such as a quarter or a year. The income statement is based on the formula:

Net Income = Revenues – Expenses

Income/Revenue:

Income is the amount of money a company earns from its regular operations, such as sales and services. There are also other forms of income, such as income from interest on investments, dividends, etc.

Expenses:

Expenses are the costs associated with running a business, such as salaries, rent, equipment, and supplies.

Profit or Loss:

Profit or loss (net income) is the difference between revenues and expenses. A positive number indicates a profit, while a negative number indicates a loss.

Cash Flow Statement

The cash flow statement shows the inflows and outflows of cash and cash equivalents over a specific period of time. It includes three sections: operating activities, investing activities, and financing activities. Whereas the income statement deals with revenue and expenses incurred (but not necessarily received or paid yet), the cashflow statement provides an accurate record of the actual amount of money paid out and received by the business.