Debits and Credits - New Project 2

In bookkeeping, every financial transaction is recorded using a system called double-entry accounting. This means every transaction affects at least two accounts. If something goes out, something else must come in. Think of double-entry bookkeeping as the central nervous system of modern business. It is a system that has been used for centuries because it has a built-in mechanism for accuracy: every single financial event has a cause and an effect.

In double-entry bookkeeping, every transaction affects at least two accounts. If you take money out of one place, it must go into another. This ensures that your financial records always stay perfectly balanced. In other words, the double entry bookkeeping system keeps the Accounting Equation

What do we use to record the changes, the increases and decreases to account balances ?

To keep track of these changes, we use Debits and Credits.

Instead of thinking of these terms as "plus" or "minus," or "good" or "bad," it is best to learn their simplest definition in accounting:

Every single transaction you record using the double entry bookkeeping system will have a debit entry on the left side of one account, and a corresponding credit entry on the right side of another account.

The Golden Rule of Bookkeeping: Total Debits must always equal Total Credits for every transaction.

The Accounting Equation: Whether a debit or a credit increases or decreases an account depends entirely on the type of account you are working with. Everything ties back to the Expanded Accounting Equation: Assets equal Liabilities plus Owner Capital minus Owner Drawings plus Revenues minus Expenses.

Here is how the rules break down for the main account types:

1. Assets (What the business owns - Cash, Inventory, Equipment) Increase with a Debit (Left side) and Decrease with a Credit (Right side)

2. Liabilities (What the business owes to others - Accounts Payable, Loans) Decreases with a Debit (Left side)and Increases with a Credit (Right side)

3. Equity (The owner's investment and value in the business) Decreases with a Debit (Left side)and Increases with a Credit (Right side)  

(a) Owner's Capital (What the owners invest in the business) Decreases with a Debit (Left side)and Increases with a Credit (Right side)

(b) Revenue (What the business earns- Sales of products and services) Decreases with a Debit (Left side)and Increases with a Credit (Right side)

(c) Draws or Dividends (Money taken out of the business by the owners) Increases with a Debit (Left side) and Decreases with a Credit (Right side)

(d) Expenses (Costs of running the business - Rent, Utilities, Advertising) Increases with a Debit (Left side) and Decreases with a Credit (Right side)

Let's end with a complete definition for debits and credits.