How double entry works
Double-entry bookkeeping starts from the duality of transactions: every transaction has two sides. Buying equipment with 1 million won in cash increases equipment (an asset) and decreases cash (an asset). Both effects are recorded as a debit (left) and a credit (right) of equal amount, so total debits always equal total credits. This is why a trial balance can be used to check for recording errors.
- Accounting equation: Assets = Liabilities + Equity. Revenue and expenses feed into the equation through changes in equity.
- Recording cycle: transaction → journal entry → posting to the general ledger → trial balance → adjusting entries → financial statements.
History
Double entry developed in the trading cities of Italy in the 13th and 14th centuries. The bookkeeping section of the mathematician Luca Pacioli's Summa, printed in Venice in 1494, is regarded as the first printed text to explain it systematically. Sombart argued that double entry helped rational capitalism develop, while Yamey (1949) criticized that influence as overstated. In Korea, the Sagae Songdo bookkeeping of Kaesong merchants is known as an indigenous double-entry method, introduced in book form by Hyeon Byeong-ju (1916).
Cash basis and accrual basis
The cash basis records revenue and expenses when cash comes in or goes out. The accrual basis recognizes revenue when goods or services are provided and matches the expenses incurred to earn it to the same period. This creates items whose timing differs from cash flows, such as receivables, accrued expenses, prepaid expenses and depreciation. The IFRS Conceptual Framework likewise states that accrual accounting gives a better basis for assessing an entity's past and future performance than information about cash receipts and payments alone.
Adjusting entries and accruals
At period end, adjusting entries record accrued revenue, accrued expenses, unearned revenue, prepaid expenses, depreciation and allowances for doubtful accounts. The difference between net income and operating cash flow is called accruals. Because accruals involve estimates and judgment, they also leave room for managers to manage earnings, a topic continued in earnings management and big baths.
Significance and limits
Double entry made error checking possible and lets financial position and performance be seen together, while accrual accounting shows period performance more accurately. Accrual earnings depend on estimates, however, so it is important to read them alongside the cash flow statement when judging earnings quality. The information gap between shareholders and managers links to agency theory.
References
- Pacioli, L. (1494). Summa de arithmetica, geometria, proportioni et proportionalità. Venice: Paganino de Paganini.
- Yamey, B. S. (1949). Scientific bookkeeping and the rise of capitalism. The Economic History Review, 1(2-3), 99-113.
- Sangster, A. (2016). The genesis of double entry bookkeeping. The Accounting Review, 91(1), 299-315.
- IASB (2018). Conceptual Framework for Financial Reporting. London: IFRS Foundation.
- 현병주 (1916). 『사개송도치부법』. 경성: 덕흥서림.