Whole Farm > Other > Record Keeping and Computers

Understanding Double Entry Accounting

File C6-33
Updated July, 2009

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Farm families have traditionally used the single entry (often referred to as cash) method of accounting for their farm business. This is a relatively simple method of accounting where items are listed as income and expenses when a cash transaction occurs. For example, grain is recorded as income when it is converted to cash, that is, sold and delivered. Also, production inputs like seed, feed and fertilizer are recorded as expenses when they are paid for rather than when they are used or ordered.

The single entry method of accounting does a poor job of recording the true profitability of a business within or between accounting periods. For example, crops can be sold in a year other than when they are grown and expenses can be paid in the year before or after the inputs are used.

To correct this problem, cash accounting uses an adjustment where inventories of production inputs and inventories of crops and livestock are taken at the beginning and end of the accounting period (e.g. calendar year) to adjust the income statement to a form of accrual accounting. The inventories shift production inputs and inventories of crops and livestock into the year in which they are used or produced rather than when they are purchased or sold.

Double entry accounting goes a step further. Every time an income or expense transaction occurs and an entry is made, the net worth statement is updated at the same time.

The two financial statements encompassed in double entry accounting are the net worth statement (also called the balance sheet or equity statement) and the income statement (also called the profit and loss statement). Actually the income statement becomes part of the net worth statement, as described below.

Traditionally, in single entry accounting, the net worth statement is only prepared or updated at a specific point in time. Often this is the beginning of a new year. The net worth statement is usually not updated again until the following year. In double entry accounting, the net worth statement is updated every time an entry is made. So the balance sheet changes from being a static financial statement (updated only periodically) to a dynamic financial statement that is always current.

In double entry accounting, the net worth statement is constructed using cost basis values rather than market values. This means that assets are valued at their original cost (adjusted for depreciation) rather than their current market value. So net worth or equity only increased or decreases as a result of profit or loss from the business, or from a non-business cash infusion or withdrawal.

With single entry accounting, the profit or loss for the accounting period is transferred from the income statement to the balance sheet when a new balance sheet is prepared, usually on January 1. With double entry accounting, the income statement is part of the equity section of the net worth statement, so net worth is updated every time an entry is made. As a result, the equity portion of the net worth statement increases or decreases every time revenues or expenses are posted. Noncash income, such as grain placed into storage, can be entered when harvest is completed. Noncash expenses, such as depreciation, are usually entered at the end of the accounting year.    

For a complete explanation of double entry accounting, view the PDF file available here.

Which System Should I Use?

The best system for you will depend on your individual situation. Below are some of the advantages and disadvantages of each system.

Single Entry (cash) Accounting

Advantages

  • Simple - accounting entries limited to recording cash transactions (except for capital assets)
  • Provides information for income taxes purposes
  • Is familiar to the agricultural community.

Disadvantages

  • Limited ability to track financial performance through the year.
  • Limited ability to do financial analysis.
  • Does not provide net worth analysis (unless balance sheet is updated)

Double Entry Accounting

Advantages

  • Net worth statement is always up-to-date
  • Same data builds both the income statement and the net worth statement.
  • Accrual adjustments are made automatically
  • Provides access to current and detailed financial information throughout the year to track financial performance and conduct financial analysis.

Disadvantages

  • More complex and time consuming than cash account.
  • Is an unfamiliar system to most agricultural producers.
  • Many of the traditional “tax” adjustments methods used in cash accounting (e.g. purchasing inputs in the previous year, delayed payment of grain sales, cannot be used)

As a general rule, single entry accounting may be best if you have a simple business and your main purpose for keeping records is for income tax purposes. Conversely, if you have a complex business and want to perform financial analysis throughout the year, the double entry system may be best. If you just want to do year-end financial analysis, single entry accounting with accrual adjustments at the end of the year may be preferred.

For a complete explanation of double entry accounting, view the PDF file available here.

 

Laura Hofstrand, accountant, Des Moines Diocese, Catholic Church
Don Hofstrand, retired extension value added agriculture specialist, agdm@iastate.edu