Debits and Credits in Accounting
When people discuss debit vs credit, they are usually referring to double entry accounting. More specifically, a debit and credit are recorded for each transaction. These two are required for each transaction in order to keep the accounting equation in balance. There is more information about this in the next section.
Today’s accounting software is also based off of the debit and credit account ledgers. In fact, these programs also offer mobile applications to manage your business’s finances on the go. Even if new software reduces the need to understand debits and credits, it is still essential for business owners and managers to be comfortable with. For example, if one has to record an unusual transaction or correct a mistake, it is often necessary that he or she understands double entry bookkeeping.
What is Double Entry Bookkeeping?
Double entry bookkeeping is a method of recording business transactions using at least two accounts for each transaction. Each account receives a debit on the left side or a credit on the right side. Together, the debits and credits keep assets equal to liabilities plus shareholders’ equity. For example, imagine Business A purchases equipment using cash from Business B. Business A would record a debit to equipment, to increase this asset account, and a credit to cash, to decrease this asset account. Business B would record two transactions: a debit to cash and a credit to revenues, as well as a debit to COGS and a credit to Inventory.
The rules are not quite intuitive. They say to increase assets and expenses with debits and decrease with credits. On the other hand, increase liabilities and revenue with credits and decrease with debits. It takes memorization and commitment to learn these rules, but it pays off by having a better grasp of a company’s books.
Debits and Credits for a Bank
One reason people have such a difficult time learning the difference of debit vs credit is their experience with bank accounts. When a business deposits money into a bank, it credits its account. Conversely, if you have a recurring charge, debit the account to decrease its amount. This is the opposite of the rules stated above for double entry accounting. Why are the bank’s debits and credits confusing? Banks are in the business of lending money. This means that a client’s deposit is a liability on their books; thus, it increases with a credit.
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