In Round 1, we learned the very basics of debits and credits, but this time around, we're going to step it up a notch. If you need a quick refresher, take a second to look over what we discussed last time.
To start this round we'll talk about the T-Account, which consists of three parts- the title, the left side (aka debit), and the right side (aka credit). It's called a T-Account because in its most basic form, it looks like a "T"
Any time you enter an amount on the left side, you debit the account, and any time you enter an amount on the right side, you credit the account (remember from last week that increases in assets or decreases in liabilities are debits and vice-versa for credits).
Remember the law of conservation? It says that matter cannot be created or destroyed, and the same holds true when you're talking about money. We can't just pull money out of thin air (unfortunately) and place it into an account. You have to take it from one account to put into another, which is why each transaction you make affects multiple accounts. It also means that debits must equal credits after every transaction.
In order to keep track of the debits and credits, the double-entry system (and chart of accounts) was created. With the double-entry system, any amount entered into the accounting records shows up in two different places.
Let's use this as an example: Your business company makes and sells boxing gloves and you make a sale. When a customer pays cash for the gloves, an account would show the cash received in the Cash account (as a debit) and in the Sales account (as a credit).
Using the double entry system has its benefits because it helps to spot any errors that might pop up when making entries.
If you can remember all of this, you're ready for Round 3- The recording process.
Ok, so the showdown isn't debits versus credits, its debits and credits versus our understanding of them... or lack thereof. Hopefully by the end of this match you'll come out victorious.
With that said- LET'S GET READY TO RUMBLE!
Any good boxing coach will tell you two things. The first is to get to know your opponent, so that's exactly what we'll do and the best way to do that is to throw out everything that we think we know about them.
Why? Because in the world of bookkeeping and accounting analysis, they mean the opposite of what you might be thinking.
Which brings us to the second thing a boxing coach would tell you: never underestimate your opponent...
For example: if you go to the bank and deposit money, the teller will tell you that you have credited your account. On the flip side if you go to your bank and withdrawal money, the teller will tell you that you have debited your account. But that is not the case in the accounting world...
Despite what you might be thinking, debit doesn't mean loss and credit doesn't mean gain. The true meaning of debit and credit are actually very simple, debit means left and credit means right on a T-Account (don't worry, we'll cover T-Accounts more in Round 2).
Debits are account entries that result in the increase of an asset or decrease in a liability.
Credits are account entries that result in the increase of a liability and the decrease of an asset.
Remember from before: Assets are what your business owns, liabilities are what your business owes.)
So why does the bank tell you that you credited your account when you put money in? It helps if you think of it from their end. When you deposit money into the bank, their liability to you increases, meaning it's a credit. When you withdraw money, the bank reduces their liability to you, which means it's a debit. It's tricky I know, but just remember that banks are thinking of their assets and liabilities, not the other way around.
That's it for the first round. Next round, we'll talk about the double entry system. Here's a little hint to give an edge: debits must equal credits for each transaction.