This week’s CFA session has an interesting theme…
I am familiar with debit and credit outside the context of accounting.
Pretty much simple! I have my debit cards and credit cards that allow me spend money directly from my account (debit cards) or from my line of credit with my bank (credit cards). In this sense, debits are viewed as money drawn from my bank account, and credits are viewed as money available to spend or borrowed from the bank. This is how debits and credits are represented on my bank account statement. Its just that simple! Isn’t it?
Compared to the world outside of double-entry accounting, the definitions and functions of debit and credit are extremely different, and I must admit, a little puzzling. The distinction between the two will be important for you to grasp if you are going to use them to keep track of your business transactions across the many sorts of accounts that you have in business. Every transaction (sentence in the story of what happened to the money) has to be well interpreted and must have a debit and a credit. Accounting professionals use T-accounts to help them think through transactions and journal entries to record them.
Using a T-account, you can keep track of all of your business transactions as debits and credits (abbreviated as Dr and Cr, respectively) in your accounting records. Debits are recorded on the left-hand side of the “T,” and credits are recorded on the right-hand side. This is precisely where the term “double-entry accounting” comes from: each transaction necessitates the creation of both a debit and a credit entry in the account ledger. In the pen and paper days all debit and credit transactions were recorded as journal entries. Today, computer programs like do the journal entries. Today, computer programs like QUICKBOOK do the journal entries for you in the background.
The source account, the account where the money for the transaction is coming from, is generally credited on the right-hand side. The destination account, where the money for the transaction is going, is debited on the left-hand side.
In order for a journal entry in the account ledger to be valid, the total debits must be equal to the total credits. i.e the total entries on the left-hand side of the T-account must equal the total entries on the right. In other words, the account has to be balanced. And for my science folks, we can say the account has to be in a state of equilibrium. Hehe
Don’t you wonder how you can identify the accounts involved and how you can determine the type of balance, whether its credit or debit?
Well, I did too…. But then we have a cheat code.
“DEAL CLIP”.- Deal clip covers all the element of the financial statement.
It reflects the type of balance, debit or credit, a particular account is expected to have based on its account type.
Debit all Drawings, Expenses, Assests, Losses
Credit all Capital Liabilities, Income and Profits
LoL….thank me later!