Debits and Credits: The Reverse of Bank Alerts!

Debits and credits are the foundation of double-entry accounting. They indicate an amount of value that is moving into and out of a company’s general-ledger accounts. For every transaction, there must be at least one debit and credit that equal each other. When that occurs, a company’s books are said to be in “balance”. This is when a company can go ahead to prepare its income statement, balance sheet and other financial documents. 

The Debit-Credit: Understanding the Basics

In financial accounting, every transaction involves a dual entry system: a debit and a credit. These terms, often met with confusion, do not represent increases or decreases in value; instead, they signify the impact a transaction has on different accounts. Here’s a basic breakdown:

• Debit:
  • Increases assets or expenses
  • Decreases liabilities or equity
• Credit:
  • Increases liabilities or equity
  • Decreases assets or expenses

Understanding these foundational rules is crucial for maintaining the accounting equation: Assets = Liabilities + Equity. Every transaction must maintain this balance through proper debiting and crediting.

A simple acronym to use is: DEAL CLIP

Debit all:

Expenses (rent, utilities, maintenance, salries, taxes, ads, software, utilities, marketing, e.t.c).

Assets (Property, Plant and Equipment (PPE), Cash equivalents, prepaid expenses, account receivables, investments, inventory, intellectual property, e.t.c)

Losses.

Credit all:

Liabilities (loans, account payables, accrued expenses, borrowings, unearned income, notes payable, e.t.c.)

Income (Dividend income, commission, interest income, sales, gross earnings, e.t.c)

Provision (provision for bad debts).

Debits and credits underpin a bookkeeping system called double-entry accounting, in which every transaction equally affects two or more separate general-ledger accounts, such as assets and liabilities. Debits and credits are like the yin and yang of accounting, interconnected and responsible for keeping a business’s bookkeeping entries in balance and harmony. There is no debit without a credit.

The problem with debits and credits is that they can be confusing to understand. It is not uncommon for people to get confused about which account to debit or credit. This confusion can lead to errors in financial statements, which can have serious consequences for a business. 

One way to avoid confusion is to reverse the original definition of credit and debit you know based on bank transactions. In bank transactions, debit means money is leaving your account but, in a business, debit is an increase while credit also means the reversal of bank alerts.

Another way is to remember the acronym DEAL CLIP. This stands for Debits increase Expenses, Assets, and Losses, while Credits increase Liabilities, Income, and Provision. 

You can also use T-accounts or ledger. T-accounts are a visual representation of debits and credits. They are called T-accounts because they look like the letter T. The account name is written on the top of the T, and debits are recorded on the left side of the T, while credits are recorded on the right side of the T. 

In conclusion, debits and credits are the foundation of double-entry accounting. They are used to record the movement of value into and out of a company’s general-ledger accounts. Debits and credits can be confusing, but they are the reversal of normal bank transactions.