Is it a credit or debit? Which side does a debit go again? I’m sure we’ve all scratched our heads and asked ourselves these very questions at some point or another. I know I have. The truth of the matter is that although accounting can get confusing and technical, you don’t need to be a chartered accountant to read a basic set of accounts. Often described as the language of business, accounting helps us to make informed decisions about the running of a business. All business owners, therefore, need to learn how to interpret these important reports.
As documented in The 80 Minute MBA by Richard Reeves & John Knell (which really is an 80 minute read.), the four golden rules of accounting are:
- A Double Entry system involves recording the effects of each transaction as debits and credits
- The left-hand side of an account is the debit side and the right-hand-side is the credit side.
- Total Debits must equal total credits
- The Accounting equation is: Assets = Liabilities + Capital
Today, we’re going to cover the first point in more detail and over the next 3 weeks we’ll cover points 2-4.
A Double Entry system involves recording the effects of each transaction as debits and credits. This is rule number one and what you need to remember is that each business transaction must be recorded with at least one debit and one credit. Why? Well, do you agree that in a transaction, you will always be giving something and receiving something in return? Let’s examine this a bit more.
When you receive something or something comes IN, lets say a new office desk, this is a debit in book-keeping terms. Your “office furniture” account would be debited. (This is the left hand side of the account – more on this next week)
When you give something or something goes OUT, in this example the cash to purchase the new office desk, this is a credit in book-keeping terms. Your “bank account” would be credited
(This is the right hand side of the account – more on this next week)
So the words debit and credit have very real meanings – In and Out.
Next week, we’ll take a look at how to remember which side of an account a debit and credit appears.