Cover image credit: “Accounting” by 401(K) 2012 is licensed under CC BY-SA 2.0.

We’ve already seen previously why it’s important to maintain a budget, not just for personal gain but also for protecting our planet by consuming mindfully. We’re also familiar with some budgeting basics. In this post, we’ll discuss some best practices of the mechanics of creating and maintaining an accurate budget.

The most common budgeting technique simply involves recording your income and expense transactions under the appropriate categories of “income” and “expenses” respectively. For example, if you spent 348 LCU for dining out, you may enter it in your budget as an expense transaction of 348 LCU under the category of, say “eating out”. Similarly, if you received a paycheck for 12,345 LCU, you may record it as an income transaction of 12,345 LCU under the category of, say “wages”. While this "single-entry" system of accounting is very straightforward to implement, it has a few disadvantages.

The main disadvantage of this system is that it’s prone to errors.

If you made a typo in entering the amount for a particular transaction, there’s no direct way for you to check for it. For example, if you mistyped your dining out expense as 347 LCU instead of 348 LCU, there would be no way for you to know that you had made a mistake from your budget. If enough of these mistakes occur, which is not unlikely over time¹, your budget would no longer accurately reflect your spending habits or how much you’re saving. This would ultimately defeat the purpose of budgeting!

A related disadvantage is the issue of missing transactions. Say, you decided to buy something on the spur of the moment, but forgot to enter it in your budget. Then, there’d be no way for you to figure this out from your budget later. For these reasons, this system is not the most suitable for keeping accurate records for your budget,which in turn can skew your financial picture. For example, if you routinely make impulse purchases, but forget to record them in your budget², your budget may mislead you into believing that you’re spending much less, and saving much more than you actually are. As a result, you may be disappointed to find out that your net worth is not increasing as much as your budget would suggest.

In the more extreme scenario, it may give you the false impression that you’re financially sustainable when you’re really not, since you’re not capturing all your expenses, which may lead you to believe that you’re expenses are much lower than your income.

How you can overcome the shortcomings of the single-entry method of accounting? By using, what’s appropriately named as, the "double-entry" accounting method. As the name suggests, the main difference between double-entry and single-entry accounting is that each transaction is recorded twice, in two separate “accounts”. Here, accounts refer to not just your bank or credit card accounts, but also your income and expenses. The two entries for each recorded transaction are called “debit” and “credit”.

Double-entry accounting is akin to the standard practice of entering your chosen password twice when you’re creating a new account online.

This prevents errors arising from typos, and can even catch missing transactions. How does this work in practice?

Let’s take the earlier example of dining out. Say that you paid your bill using your credit card. Then, you’d enter the dining expense as a “debit” entry in your “expense” account, and the same amount as a “credit” entry in your credit card account. Later, you can check your credit card account statement with the entries in your budget, and catch any typos you may have made in entering those transactions in your personal budget.

In the beginning, it may be a bit hard to remember which entry should be a debit one, and which one should be a credit one. To alleviate this, the following rule can be helpful.

Debit transactions add to assets and expenses and reduce liabilities and income. Inversely, credits transactions add to liabilities and income, and reduce from assets and expenses.

Following this rule, in the previous example, the expense entry was a debit entry, whereas the credit card entry was a credit entry.

While double-entry accounting may seem a bit more complex at the beginning, it’s not really that complicated once you get the hang of it. The benefits of automatic checks and balances that this method provides more than makes up for the increased effort in setting up your budget this way. In fact, this is the gold standard of professional accounting practice, and is legally required for most businesses in many countries.

No one ever said that you shouldn’t think of your personal finances as a business would think about its finances. In fact as you can see, using the same techniques as businesses do for bookkeeping, is really not a bad idea!

Double-entry accounting provides automatic checks and balances to your budget due to the following fundamental rule of this technique:

The sum of all debit amounts must equal sum of all credit amounts.

Each of your income and expense transactions should be associated with a corresponding entry in your bank statements³. So, if you make a mistake in entering your expenses, it will not match the corresponding credit entry (that you obtain from your bank statements), which makes it much easier to spot and correct the error, as we saw in the example above. Similarly, you can spot missing transactions by comparing the transactions you’ve recorded in your budget vs. what appears on your bank statements. If, for example, there’s a transaction in your credit card statement associated with an expense you forgot to record in your budget, you can easily figure out the missing expense⁴. In this way, this system is robust against errors arising out of typos or omission.

Thus, the double-entry method of accounting can help you keep an accurate personal budget, which is ultimately crucial in painting your personal financial picture, and its evolution over time realistically.