Debits and Credits - Accounting Foundations
If you've ever thought of accounting or the basics of what accounting is, one of your first thoughts may be debits and credits (debits on the left, credits on the right!) - but what does that mean? What is a debit, and what is a credit, and why are they the basics of accounting? Well my friend, read on to find out.
Either way you look at it, debits and credits are tools used by accountants to track transactions throughout a company, and when you create a debit, you will always have a credit that equals the debit. Debits and credits are easier to understand when referring to the account you are associating them with - because in some instances a debit is the "normal" account balance, but in others a credit is. So, what is an account in accounting terms? An account is the term used to describe the different "buckets" where everything is allocated to within the business on the financial statements. For example, Cash is an account that displays the amount of cash a company has, and Accounts Payable is another account that keeps track of all the company owes to their suppliers (and other various purchases) based on their spending "on account" (think of it like a credit card where you have a balance outstanding that will show how much you have spent, and that outstanding balance is your "Accounts Payable"). Accounts are under a larger group on each of the financial statements as either Assets, Liabilities, Equities, Revenue, or Expenses. This is where we can get into understanding debits and credits.
Assets and Expenses are normal debit accounts, while Liabilities, Equities, and Revenues are normal credit amounts, which means that if you want to add to an Asset account (or increase the amount in Cash, for instance), you would record that as a debit. The easiest way to remember in your head that DEBIT = ASSETS is by understanding that an asset is also considered to be something which you plan to have economic benefits from in the future, benefit - debifit - debit. Easy! (Sometimes making things silly helps with remembering and learning.) Liabilities plus Equities always equal Assets (a balance sheet), so to remember that they are always credit entries when recording an increase to these account types, remind yourself that they are the opposite of Assets (which are normal debit accounts) and you will be good to go!
With recording an increase in expenses, you can remember to always record this as a debit if you think about how you incur the expense (and expenses are always recorded in the period of which they occur – i.e. accrual accounting). An Expense is usually recorded along with the account that was used to incur the expense by either reducing an asset such as cash (paid cash for an expense) through a credit, or incurring a liability (incurred expense but going to pay for it later), also a credit. With Revenues, you will most always see the entry Dr. Account Receivables, Cr. Revenue/Sales. This is the best way to remember that Revenue is a credit account, because for most sales that are made, a customer will be provided with credit (they will have a certain time period when they have to pay their invoice), and as such the company will have a receivable due (Accounts Receivable = Asset = future value).
Thank you for reading and of course please reach out with any questions - or let me know what you thought of this post, I'd love to hear from you. And if you or someone you know is in need of an accounting tutor, shoot me an email or text and I would be happy to help! Happy Accounting!