My first day of sitting in an accounting class was a merry-go-round. Everything I thought I knew was the opposite of what it really meant in an account. Sitting in that accounts class and hearing about a whole lot of account terminologies is a new level of financial advancement. You think you know account until you start debit and credit and then sometimes when you feel like an entry is meant to be on the credit side, it falls on the debit side.
The terms debit (DR) and credit (CR) have Latin roots: debit comes from the word debitum, meaning “what is due,” and credit comes from creditum, meaning “something entrusted to another individual or a loan.” Every individual needs to have a grasp of how debits and credits work to keep your books error-free. Accurate bookkeeping can give you a better understanding of your business’s financial health. Debits and credit are used every day and play important functions in the determination of how we run and record business transactions. It is also used to prepare critical financial statements and other documents you may need to share with the bank.
For every transaction that occurs, the credit and debit are to be taken note of as usually two entries for every transaction. This method of record-keeping is called double-entry book-keeping.
Types of accounts for which records are kept include:
Assets: Resources owned by a firm that has monetary valuation and can be converted into cash. These include vehicles, land, or cash.
Expenses: Costs that organizations incur from their core activities (e.g. wages, supplies)
Liabilities: Debt incurred that is yet to be paid for (e.g., accounts payable)
Equity: A company’s assets minus its liabilities
Revenue: Cash earned from sales of core operations or commodities.
When an account is debited or credited, it has a different impact on the account.
Based on the aspects of a transaction, there are three kinds of accounts:
- Real accounts relate to the assets of a company, which may be tangible (machinery, buildings etc.) or intangible (goodwill, patents etc.)
- Personal accounts relate to individuals, companies, creditors, banks etc.
- Nominal accounts relate to expenses, losses, incomes or gains.
The classical approach to book-keeping entails three golden rules for each type of these accounts:
- Real accounts: Debit whatever comes in and credit whatever goes out.
- Personal accounts: The receiver’s account is debited and the giver’s account is credited.
- Nominal accounts: Expenses and losses are debited and incomes and gains are credited.
To understand this better, let’s look at a few debits and credits account:
Heart and Capital is a company that sells FMCGs. They sold 400 bags of rice to a customer for $10, 000 in cash. The account officer will record this as an increase of cash (asset account) with a debit and increase the revenue account with a credit.
This would result in $10, 000 of revenue and cash of $10, 000. Imagine if the customer paid $5000 and had $5000 to balance up. The debt will be a credit entry.
To further understand this, we use the acronym “DEAL, CLIP”
DEAL= Debit all expenses assets and Losses
CLIP= Credit all liabilities income (revenue, profit, sales, turnover)