Sunday, February 16, 2014

Double-entry bookkeeping system also works across a pair of firms

We're traditionally made to believe that the double-entry system used in accounting is applicable only on an intra-firm level, that is, on the account books inside a firm. So any financial transaction a firm conducts has the effect of debiting at least one account and crediting at least one other account in the firm's books.

Taking this idea one step further, the double-entry bookkeeping system is actually also applicable on an inter-firm level. For example, suppose firm A supplies some goods to firm B, then in firm A's account books, the transaction will be recorded as a debit in the ledger of firm B. Conversely, in firm B's account books, the transaction will be recorded as a credit in the ledger of firm A.

Looking closely, this is nothing but yet another form of the double-entry bookkeeping system. This system, on an inter-firm level, ensures that the ledgers two firms maintain of each other [firm B's ledger in firm A's books and firm A's ledger in firm B's books] are mirror copies of each other [assuming no bookkeeping errors occur on either side].

Once again, just like in the traditional definition of double-entry bookkeeping system, the sum of all credits must equal the sum of all debits, even on an inter-firm level.

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