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Basic Understanding of Debits and Credits in Accounting

6th Sep 2013
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Most business transactions have two sides such as the buyer and the seller. In other words, the business sells a product to a customer who buys the product. In order for a company to be able to keep track of transactions, most use a system called double-entry bookkeeping. Double-entry bookkeeping requires a recording system using debits and credits.

Debits and credits are the two balancing aspects of every financial transaction in double-entry bookkeeping. According to Wikipedia, debits and credits are entries made in account ledgers to record changes in value due to business transactions. Generally speaking, the source account for the transaction is credited (entry made at the right of the ledger) and the destination account is the debited (an entry made on the left). The difference between the total debits and total credits in a single account is the balance. If debits exceed credits, the account has a debit balance. On the other hand, if credits exceed debits, the account has a credit balance. For a company, the totals of debit balances and credit balances must be equal as shown in the reports; otherwise, it means that an error has occurred.

According to David Friedman, an academic economist, the essence of double entry bookkeeping is that every item appears twice, once on the left side and one on the right. For example, if you buy some oil, the reduction in cash is your credit while the increase in your inventory is your debit.  The inventory is debited because it is an asset account that increases in this transaction and the payment is credited as a liability account that increases since the transaction was on credit. However, in this case, the two amounts are equal because accountants measure the value of something (the oil), by what you paid for it.

Traditionally, debits and credits are hard to understand. In fact, according to Friedman, they may mean the opposite of what they should.  For example, an increase in assets is a debit, a decrease in assets (or an increase in liabilities) a credit. In most cases, revenue is credit while expenses a debit. In other words, debit is all the expenses and losses, while credit is all incomes and gains.

To put it simply, according to Accountingcoach.com, DEAL accounts are increased with a debit: Dividends (Draws), Expenses, Assets, Losses. On the other hand, GIRLS accounts are increased with a credit: Gains, Income, Revenues, Liabilities, Stockholders’ (owners’) equity.

Ultimately, debits and credits are a bit confusing and it would take numbers of practices of bookkeeping to fully understand what these terms mean and how they go together.    

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By Old Greying Accountant
06th Sep 2013 10:27

Speak for yourself ...

... I never found it a difficult concept to grasp!

Friedman sounds a bit of a plonker, but he is an economist and look at the messes they get us in!

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By tom123
07th Sep 2013 07:52

Mnemonics

The mnemonic I got taught, which I suppose is not too PC these days:

If you drink too much

A  ssets

L  losses

E  expenses

you get a

C  apital

L  iabilities

I   ncome

P  rofit

round the ear.

 

Nowadays, like most on here, I can't think in any other way than double entry.

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By jefflcbba
07th Sep 2013 07:59

It is all rubbish!

The fact that in the 21st Century we still use "debit" and "credit" explains the mess world finance is in.

The system was invented in the 15th Century, and together with the "flat earth" and the fact that the "sun revolves around the earth" it should have been consigned to anceint history.

This process is too easy to manipulate, look at any set of books of virtually any quoted company and ask yourself whether the figures you are looking at reflect the truth.

Just as a current example take the "ethical" Co-op Bank!

The sooner accountants dump this nonense and devise a system based on future cashflow, econometrics etc, the sooner we may start to repair the damage this antiquated system has cursed us with.

If you want to read more ------go to Mad Lemming

 

 

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By Old Greying Accountant
07th Sep 2013 09:44

A bit like the ...

... "Modern Art is a con" thread - my answer is the same.

Nothing wrong with debits and credits as a concept, and they are a useful tool for measuring performance, tax debt etc.

The fact that are mis-used and cynically manipulated is down to the user niot the tool.

Any system will be open to abuse, and much easier to manipulate future cashflows than past ones surely!

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By BKD
07th Sep 2013 16:28

Keep them

As someone who has wasted countless hours sorting out problems caused by clients using single-entry systems, my vote is for double-entry to stay.

And OGA is right - just because Friedman finds the concept difficult to grasp, that doesn't mean that everyone else that has a modicum of intelligence should find it hard. Trying to rationalise why an increase in cash is a debit is the wong approach - I always treated debits and credits as nothing more than labels, so even as a non-accountancy (physics) student at Uni acting as Treasurer of the snooker club they gave me no difficulty.

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By Old Greying Accountant
07th Sep 2013 20:04

Aside from anything else ...

... debits and credits are like Newton's 3rd law - just because you don't like something doesn't mean you can deny its existence.

 

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By A mum and an accountant
10th Sep 2013 21:07

In the beginning

the fact that debits and credits were the opposite to what it meant on the bank statement used to confuse me but once I got my head around it and got used to it, it became like second nature. What I do worry about though is that people place too much reliance on computers and not really understand (or take time to understand) the basics of what they are doing.

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Replying to Adrian T:
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By Old Greying Accountant
10th Sep 2013 21:16

@Lilac1

Agree totally

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By jimmywhite007
14th Sep 2013 10:06

The concept is really easy to understand. It can also help everyone to promote their business and all accounts.<br><a href="http://www.wealthme.com" rel="nofollow">VCT</a>

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