Debits And Credits

One area of great confusion to most accounting novices, including most small business people, is the notion of a "debit" or "credit". Firstly, it is absolutely essential that it is made clear from the start that these are technical terms used by accountants. They do not have the same meaning as the terms "debit" (loss or negative balance) or "credit" (gain or positive balance) that we use in everyday English.

At this point we could spend a considerable amount of time discussing why certain asset and liability accounts are debit type, while others are credit type and so on and so forth. At this point we would gain little from the effort. Therefore, simply accept the fact that the following types of general ledger accounts have the following classifications:

Account balances in a general ledger are changed by either issuing a debit or a credit amount. Whether you wish to increase or decrease a balance depends on the debit/credit type of the account and the debit/credit type of the transaction effecting it. The following rules apply:

• Debit transactions increase debit accounts

• Credit transactions increase credit accounts

• Debit transactions decrease credit accounts

• Credit transactions decrease debit accounts

Observe one important point. A "credit" transaction will sometimes increase the balance of an account, at other times decrease the balance of an account. It depends on the debit/credit type assigned to both the account and the transaction.

One of the rules of double-entry book keeping is that for every credit transaction there must be a corresponding debit (or series of debit) transactions to offset the credit. Likewise, for every debit transaction there must be a corresponding credit (or series of credits). Again, the accounting notion of 'balance' reappears. Hence also the term 'double entry.'

Let's run through some examples:

You sell a $50 stock item to your account customer, acme. The transaction would take the form of:

Credit sales for $50. Sales is a credit account so the $50 credit increases total sales by $50.

Debit customer accounts (receivables) $50. Receivables is a debit account so this increases the amount owed to you by $50.

If you sold the same item for cash, the journal entries would be:

Credit sales $50. Sales is a credit account so the $50 credit increases total sales by $50.

Debit your bank account $50. Since your bank account is a debit account, this will increase its balance by $50.

Let's say you wish to purchase goods from a supplier for $50.

Debit your purchases account $50. Since purchases is a debit account, a debit plus a debit results in an increase to this account.

Credit your creditor the $50 amount owing. Since your supplier accounts (creditors) is a credit account, this will increase the amount you owe your suppliers by $50.

If you paid cash for the stock, then you would credit your bank account $50 instead, since the money is coming out of your cash reserves. Because a bank account is a debit account and the transaction is a credit amount, this would result in a reduced bank balance.

Debits and credits need to be taken into historical context if we are to understand the point of this system. When you raise an invoice using an accounting program such as CAPITAL Office, sales are increased, customer account balances are increased, stock levels are decreased and cost of sales is increased. The computer never adjusts your stock level then forgets to adjust your cost of sales. Yet forgetting to do such things can be a very common source of error for humans. The above procedures ensure that the total debits in the system must equal the total credits. If they don't, we know there is a mistake somewhere in our manual record keeping. In a computerised system the use of debits and credits is somewhat redundant. Their use remains mandatory for other reasons, however. Much of the world's accounting systems are not yet computerised and there are also significant historical reasons for maintaining this operational method. As a consequence CAPITAL GL Controller also uses the traditional "debit" and "credit" approach.