Understanding Accounting Basics
Debits and credits in accounting are often confused. So where did debits and credits come from, and what do they mean?
The double-entry accounting system was developed and in use during the 1400s in Italy. We know this because there are recorded documents that use the double-entry method. The double-entry accounting system operates on the basis of the fact that every transaction has two components: a debit and a credit. Debits must always equal credits. This is the basis of a true accounting system.
Debits are a component of an accounting transaction that will increase assets and decrease liabilities and equity. Credits are a component of an accounting transaction that will increase liabilities and equity and decrease assets.
By now, you should have progressed past confusion. It can be thoroughly vexing to try to remember what goes where. But there is no simple way to remember if it is a debit or credit to the account. You simply must gain an understanding of what constitutes a debit or a credit, and then make your journal entry accordingly.
Any item of financial impact that increases your assets, such as your bank balance, equipment, or accounts receivables, is recorded as a debit to the respective asset account; at that moment, you will have created a credit transaction that must be recorded.
Now, I’m going to put this into a language that anyone should be able to grasp. It’s Friday afternoon, and your car payment is due. Your car is an asset. The loan against it is a liability. You make a payment on the loan. That payment has two components: a debit and a credit. After you make the payment you will own a larger portion of the value of the car. You have increased the value of an asset (your car) as it applies to your financial net worth, and you have decreased the value of a liability (the loan). The increase in asset value is a debit to the asset account entitled “CAR” and the decrease in liability value is a credit to the liability account entitled “CAR LOAN”.
Now, that is an example everyone should be able to relate to, since 99 out of 100 individuals own cars, and owe for them.
Even if you never formally study accounting, you will be a part of the accounting process in every transaction that you complete with an exchange of currency. Every time you buy groceries, shop at Wal-Mart, or buy gas, there is an exchange of account values. There is a debit and a credit. Most of you will never even think about the cause and effect created by purchases, monetary exchanges, or trips to the grocery store. But for the accounting professionals, every day is a debit or credit, an exchange of value between assets and liabilities.