Long ago, after proudly surviving my first formal accounting classes, I was confronted by a CPA friend of mine (Tom K.) with a mind-numbing quiz. If you’re so smart Tim, then tell me, what is a debit and what is a credit?
I proceeded to launch into a picture-perfect and lengthy explanation of debits and credits. When I finally finished my erudite spontaneous pontification on “debits and credits”, Tom loudly chided me, saying “FLUNK – debits on the left, credits on the right”.
Remember that one – I sure did.
DEBITS ON THE LEFT – CREDITS ON THE RIGHT
That’s it – very simple actually; debits on the left, credits on the right.
In today’s double-entry bookkeeping system, instead of using one column for each account and entering one number as positive and the other as negative, we use two columns for each account with only positive numbers. Whether the entry increases or decreases the account is determined by choice of the column in which it is entered. Entries in the left column are referred to as debits, and entries in the right column are referred to as credits.
In double-entry bookkeeping, at least two accounts are impacted by each transaction, one of those entries must be a debit and the other entry must be a credit of equal amount. To complicate things further, more than two accounts can be used if the transaction is split among them, as long as the sum of debits for the transaction equals the sum of credits. Oddly enough, they must balance (cancel each other out, if you think about it) to zero.
That’s one of the beauties of QuickBooks – the user is spared the decision-making process of “what do I enter here ….. debit or credit?”.
The truth is, whether a debit or a credit increases or decreases an account balance depends on the type of account. Asset and expense accounts are increased on the debit side – liability, equity, and revenue accounts are increased on the credit side.
QuickBooks obscures the credit/debit aspect of transactions, which is not always a good thing. QuickBooks strength can also be a curse. If you don’t “grok” the concept of debits and credits as they apply to specific types of accounts, QuickBooks may allow you to merrily enter transactions incorrectly.
That’s where the double-entry bookkeeping system can help – it provides a system of checks and balances.
By adding up all of the debits and adding up all of the credits and comparing the two, differences stick out like a sore thumb out and you have the chance to correct any errors. When debits and credits don’t match – the “double-entry bookkeeping” system loudly tells you something is wrong and needs correction. In fact, QuickBooks will actively prevent you from entering “out of balance” (meaning the debits and credits don’t match) transactions. However, QuickBooks will NOT always stop you from incorrectly assigning debits and credits to your accounts.
To avoid confusion over debits and credits, don’t think of them in the way they are used in everyday language.
You may be confused because you thought credit was a good thing! We learned these terms from dealing with banks and stores, but they were using the terms from their perspective.
When the bank gave you a “credit”, it was their Cash they are crediting, or subtracting from.
Good for you, not good for the bank.
As a business owner, think of debits and credits from your company’s point of view. When you debit your Cash, you add to it. When you credit your Cash, you subtract from it.
When you put cash in the bank, the bank now is obliged to pay it back to you, which is a liability and therefore a credit (increase) of their liability to you. So the teller tells you your account has been “credited”.
See how this can get confusing now? See how the two of you, your company and the bank mirror image each other? The “credit” from the viewpoint of the bank is, in fact, a debit from your business point of view. Fascinating (as Spock would say), if you think about it.
The confusion can be eliminated by remembering the basic concept. Debit refers to the left; credit refers to the right.
And no, it does not mean Democrats are debits and Republicans are credits.
What do you think? Has this helped shed light on the subject?
Tim WakelyIn conclusion, RPPC, Inc. assists entrepreneurial, forward-thinking, business and association managers/owners in Realizing Profitable Potential through Change by providing training and services in the areas of Accounting and Financial Management, specializing in QuickBooks® as the tool of choice. Give us a call at 1.888.536.9690 to see how we can help you improve your bottom line!