In order to keep track of the money coming into and going out of your company's account, you can utilise debits and credits. A credit is money that is added to the account, while a debit is money that is taken out of the account in a straightforward system. On the other hand, the majority of companies employ an accounting method called double-entry. When a new business owner sees the same funds being utilised as a credit in one place but as a debit in another, it is easy for them to become perplexed.
Money is removed from an account when a debit is processed; this action raises the total balance of dividends, expenses, assets, and losses. When money is deposited into an account, this is known as a credit, and it contributes to a rise in the overall balance of gains, income, revenues, liabilities, and shareholder equity.
Double Entry Accounting
When you examine the financial aspects of your company, you will notice that every transaction has two sides. This indicates that the account for the rent is one with an outstanding balance, and the account for the company checking is another account that pays the outstanding balance. Therefore, the same amount of money is moving, but it is being used to account for two different things. The chart of accounts is produced by using the double-entry approach. These include things like the rent, the vendors, the utilities, the payroll, and any loans that may be required.
The terms “Debits” and “Credits”
Due to the fact that these two are being used concurrently, it is essential to have a solid understanding of their respective places in the ledger. It is important to keep in mind that the majority of corporate accounting software keeps the chart of accounts running in the background while you look at the main ledger. The balance of dividends, expenses, assets, and losses all grow as debits are applied. To the left of the main ledger column is where you should record any debits. The overall balance of profits, income, revenues, liabilities, and shareholder equity all grow when credits are applied. The credits are listed over there on the right.
Debits and Credits in Action
When employing debits and credits, it is important to give some thought to the purpose of the transaction. At first appearance, it may appear contradictory to have a debit increase the balance of an asset while simultaneously having a credit lower it. On the other hand, the following equation is used to determine the value of an asset:
Assets = liabilities + equity
As a result, assets have to be computed by taking into account both obligations and equity. This indicates that everything that is being added to the liabilities is considered a debit, and it should be recorded in the left column.
Here is an Example
Take this example into consideration. You spend a total of five hundred dollars buying materials on credit from a wholesaler. You would make a credit to the accounts payable account and a debit to the supplies expense account. Because his company makes use of the double-entry system, the proprietor possesses an accurate awareness of the status of his company's finances. He is aware of the precise quantity of cash that he currently possesses in addition to the sum total of the obligations and commitments that he is obligated to meet.
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