Debits and Credits – Double Entry Accounting

In accounting, debits and credits are used to record financial transactions. When a transaction is recorded, a debit is entered on one side of the ledger, and a credit is entered on the other. This process is known as double entry bookkeeping, and every transaction is posted in at least two accounts.

Note: Each business transaction will have a debit entry and at least one credit entry. The debits and credits will have equal amounts and, therefore, balance.

This article will look at Debits and credits, the general ledger, different types of accounts and financial reports.

Debits and Credits Explained

Debit entries reflect an increase in assets or a decrease in liabilities, while credit entries reflect a decrease in assets or an increase in liabilities.

Debits must always equal credits for the books to remain balanced. As a result, debits and credits play an essential role in accounting by providing a way to track financial transactions and ensure that the books remain balanced.

Every transaction has two entries: a Debit (Dr) and a Credit (Cr). In accounting software, the transactions are posted for you. If you are running a manual system, you may need to post them yourself.

Everyone studying accounting must learn the difference between Debits and Credits and how to use journals to make adjustments.

How to Record Debits and Credits

Using accounting software is the easiest way for a business to record debits and credits. It streamlines the processes and reduces errors. Here are the advantages of using accounting software:

• Automation – Debits and credits are posted automatically as they are double entry systems, reducing manual data entry.
• Journal Entries – Simplifies journal entries for adjustments.
• Real-time Information – The general ledger is current, allowing for the creation of financial reports.

General Ledger – Debit and Credit Accounting

The general ledger is the backbone of any accounting system. It contains all the information necessary to prepare financial reports and tax returns. The ledger is divided into several types of accounts, including:

Asset account

When a company acquires a new asset, it records the asset in an asset account. The asset account shows the asset’s original cost and any subsequent changes in the asset’s value.

The asset account is also used to track depreciation, a decline in the asset’s value over time due to wear and tear. Depreciation is recorded as an expense on the income statement.

Liability Account

The liability account on a company’s balance sheet includes all of the money that the company owes. This can include money owed to suppliers, money owed to lenders, and money owed in taxes. The liability account is typically divided into several different sub-accounts, each of which represents a different type of liability.

Cash Account

The cash account in the general ledger is used to track all cash inflows and outflows for a business. This includes money in the bank account, cash, and credit cards.

The cash account is used to reconcile the bank statements at the end of each month. By tracking all cash transactions, businesses can better manage their finances and ensure they are on solid footing.

Income or Revenue Account

A revenue account is an essential part of business accounting that records revenue. This can include money earned from selling products or services, interest income and other forms of revenue.

Revenue accounts are typically divided into two categories: operating revenue and non-operating revenue. Operating revenue includes money earned from the primary business activities, while non-operating revenue comes from other sources, such as investments.

Expense Account

An expense account is a record of all the money that a company has spent on operating costs. This includes things like rent, salaries, marketing costs, and travel expenses.

The expense account is used to track spending and help businesses manage their budgets. It is important to keep accurate records of expenses in order to make informed decisions about where to allocate resources. Ultimately, the expense account is a valuable financial tool that can help businesses save money and improve their bottom line.

Equity Account

The equity account on the balance sheet is a record of the equity that the owners have in the company. It will include any shareholder’s equity.

Accounts Receivable and Accounts Payable

The accounts receivable account and accounts payable account are two important aspects of accounting.

Accounts receivable is the money owed to a company by its customers, while accounts payable is the money that a company owes to its suppliers. Both accounts receivable and accounts payable must be managed carefully to keep a company’s finances healthy.

Accounts receivable can be managed by ensuring that invoices are sent out promptly and that payments are collected promptly. Prompt payment of invoices ensures that a company has the cash to pay its bills when they are due. In addition, accounts receivable can be managed by offering discounts for early payments, encouraging customers to pay their invoices quickly.

Accounts payable can be managed by ensuring that payments are made on time. This helps to avoid late fees and penalties, and it also helps to maintain good relationships with suppliers. In addition, accounts payable can be managed by taking advantage of early payment discounts.

The Differences between debits and credits in the General Ledger

In accounting, debits and credits are used to record financial transactions. A debit is an entry on the left side of a ledger, which indicates an increase in assets or a decrease in liabilities. A credit is an entry on the right side of a ledger, which indicates a decrease in assets or an increase in liabilities. In the general ledger, debits and credits must always balance.

This means that the total debits must equal the total credits. When recording debits and credits, it is essential to use the correct accounting principle. For example, if a company purchases inventory with cash, the Cash account will be credited, and the Inventory account will be debited. If a company pays off a loan, the Loan account will be debited, and the Cash account will be credited.

By understanding how debits and credits work, you can ensure that your financial records are accurate and up-to-date.

Debits and Credits Rules

There are several rules which will make it easier to learn.

• Accounts are made up of a T with debits on the left and credits on the right.
• For each debit, there must be an equal credit. In some cases, you may need to post to more than one account; you need to ensure that the two sides balance.
• Debits increase asset or expense accounts and decrease liability or equity.
• Credits decrease assets and expenses and increase liability and equity.

There are two acronyms to help you remember this:

DEAL – Generally, these types of accounts are increased with a debit: Dividends, Expenses, Assets, Losses.

GIRLS – Generally, these types of accounts are increased with a credit: Gains, Income, Revenues, Liabilities, Stockholders’ Equity

Debits and Credits Cheat Sheet

Our Debits and Credits cheat sheet below will help you to visualise the difference.

The highlighted green on assets and expenses shows an increase in assets and expenses. Highlighted green on Liabilities, Capital, and income show a decrease.

The red shows a decrease in assets and expenses but an increase in liabilities, capital and income.

Debits and Credits Example

Here is an example of debits and credits:

A business pays a wage of 500.00 to a staff member. The wage is an expense, so will be a debit, and the balancing credit will be to the bank.

The Three Financial Statements

Any business owner knows that financial statements are essential for understanding the health of their business. The three main reports are the income statement, balance sheet, and statement of cash flows.

The balance sheet report for small business

The balance sheet is one of the most important financial reports for any business, large or small. It provides a snapshot of a company’s assets, liabilities, and equity account at a given point in time.

The balance sheet can be used to assess a company’s financial health, identify trends over time, and compare its performance to that of its peers. For small businesses, the balance sheet can be particularly useful in understanding where they stand financially and making informed decisions about their future.

The balance sheet report for small businesses includes both debits and credits. Debits represent a company’s funds on hand, while credits represent the funds it owes.

The income statement

The income statement is one of a business’s most important financial statements. It shows a company’s revenues and expenses over a period of time and its net income or loss.

It shows in the revenue accounts first, followed by the expense accounts.

The income statement can be prepared monthly, quarterly, or yearly. Businesses need to track their income and expenses to make informed decisions about where to allocate their resources. The income statement can also be used to assess a company’s financial health and compare its performance to other businesses in its industry.

The cash flow statement

A cash flow statement provides information on how cash has moved in and out of business and can be used to make investment, spending, and cash management decisions. The cash flow statement has three main sections: operating activities, investing activities, and financing activities.

Operating activities include cash generated from day-to-day operations, such as sales and expenses. Investing activities include cash flow from long-term investments, such as purchasing equipment or property. Financing activities include cash from sources such as loans and equity investments.

By understanding the cash flow statement, businesses can make informed decisions about best use of their cash resources.

Trial Balance

At the end of a period, a trial balance report will be produced; this will include all the debits and credits from the general ledger, and both sides of the report will balance.

If an adjustment is required on an account, a journal entry will be created. As with all double entries, two transactions will occur a debit and a credit.

Debits and Credit Conclusion

Though it may seem daunting at first, understanding the basic concepts of accounting is essential for anyone who wants to enter the business world. By learning about accounts receivable and accounts payable, debit and credit, and the four financial statements, you can better understand how businesses keep track of their finances.

This information will be essential as you begin navigating the business world. Are you interested in learning more about debits and credits? Check out our blog post on why debits and credits are essential in accounting.

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