Understanding Double Entry Accounting

Sir Isaac Newton’s third law of motion, the law of reciprocal actions, states that for every action there is an equal and opposite reaction. The same can be said for accounting. For every financial transaction, there are two sides. There is a debit side and a credit side. For each transaction, these sides must be equal for your books to balance.

To understand double entry bookkeeping, you must first understand what is a debit and what is a credit. Simply put, a debit is something you own or money owed to you, and a credit is money owed to someone else. Let’s look at this in terms of the different types of accounts a business has.

Assets: these are debit items, as they are items that are owned by the company. An asset increase is a debit and an asset decrease is a credit.

Liabilities: these are elements of credit, since they are elements that the company owes to another person. An increase in liabilities is a credit and a decrease in liabilities is a debit.

Owner’s Equity – This is a credit account because the owner’s equity account balance is the money the business owes to the business owner. An increase in the owner’s equity is a credit and a decrease in the owner’s equity is a debit.

Expenses – These are debit items because the purchase of an expense item decreases an asset item (for example, cash in the bank) that is the credit site for the transaction.

Revenue – These are credit items because the receipt of revenue increases an asset item (for example, cash in the bank) which is the debit side of the transaction.

Let’s look at a simple example:

Let’s say you want to go to the store to buy a bottle of milk, which costs $ 3. Your purchase of milk is a financial transaction. Before entering the store, he owns $ 3, so this is a debit item, which is balanced against the owner’s equity.

When you go to the store and pick up the bottle of milk, you now have a bottle of milk, which is worth $ 3, and you owe the store owner $ 3. Therefore, the bottle of milk is a debit and the $ 3 you owe is a credit.

When you pay the shop owner for the milk bottle, you are reducing the amount of money you have (the debit item will be credited) and also the amount of money you owe (the credit item will be charged).

Note that at each step of the transaction, the debit and credit side of the transaction are the same and the balance of all accounts has the same debit and credit sides.

So what happens when you drink the milk bottle? He no longer has a $ 3 bottle of milk; You have an empty bottle that is worth nothing! That’s why we have expense accounts. Assets, which are debit items, are things that the company owns for a long period of time. Expenses, which are also debit items, are things that the business owns for a short period of time before they are used up.

This is why we have two separate main reports for a company. The balance is used for those elements that are constant in a business. The profit and loss statement (or income and expense statement) is used for those items that enter and leave a company on a regular basis. The resulting balance from the income statement is placed in the equity section of the balance sheet to balance things out.

Another report you may have heard of is the trial balance. This is used to make sure you have not made a mistake before preparing the balance sheet and income statement. At the end of an accounting period, the closing balance of all your accounts (assets, liabilities, owner’s equity, expenses and income) is included in this report to ensure that your debits are equal to your credits. If not, you know you’ve made a mistake somewhere, and you will need to find your mistake before preparing your main reports. The total in the debit column must equal the total in the debit column.

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