Bookkeeping: Making Sense of Debits and Credits!

Wednesday, 6 Nov 2019

Running a business is no child’s play. You have to be a jack-of-all-trades to stay ahead in the cut-throat competitive world. Besides tracking the administrative work, human resources, stock management, customer relationship management and marketing, you need to have a basic understanding of bookkeeping.

You might hire a professional bookkeeper in Melbourne to do the job, but having your basics cleared is imperative. You don’t have to be a mathematical genius to understand the profitability of your enterprise or anticipate a financial crisis. You don’t even have to bury your head into oversized accounting journals.

You need to know about the debits and credits so that you can analyse the financial data for a better future of your organisation in Melbourne. Here is how you can make sense of the two commonly used terms.

 What Are Debits And Credits?

The double-entry bookkeeping system involves the use of debits and credits to record business transactions in the accounting system. An increase in asset or expenses account or a decrease in liability or the equity account is marked as a debit in the records. On the other hand, an increase in liability or equity account or decrease in asset or expenses account is marked as a credit in the records.

While debit is mentioned on the left side of the ledger, credit is positioned on the right side. They appear as mirror images of each other as the amount of debit must be equal to the amount of credit for any transaction.

In simple terms, when money is spent during a business transaction in Melbourne, it is considered credit, and when capital is received, it is termed debit. Thus if a debit entry is made in an account, then a credit entry needs to be made in the opposite account to maintain the balance.

The double entry system works on two accounts – debit and credit and they cease to exist without each other. The accounts which are increased through debit include dividends, assets, expenses and losses. The accounts which increase with credit are gains, liabilities, income, revenues, and stockholder’s equity.

Credit showcases the source of the withdrawal and debit represents the usage of the value of the transaction. Bookkeepers often refer to debits as dr. and credits as cr. Debits and credits can be only used in a double-entry bookkeeping system as they are interdependent.   

How Are The Accounts Maintained?

The financial data is managed by bookkeepers through the creation of records for individual transactions called accounts as they aid in financial reporting of businesses in Melbourne. The accounting system of business lists down all the accounts that get affected by the transactions.

These accounts are further divided into a few key categories, namely assets, liabilities, equity, expenses, loss, gains and revenues. While accounting in Melbourne, you must know that there are some accounts which mainly receive debits or credits and thus are known as debit accounts and credit accounts.

Here are some accounting rules which can make recording transactions easier.

  • For asset accounts, a debit enhances the balance and a credit brings it down.
  • For liability accounts, a debit takes the balance down and a credit moves it up.
  • For equity accounts, a debit reduces the balance and a credit improves it.

This might seem confusing, but the role reversal for different accounts happens due to the accounting equation which is the foundation of the bookkeeping system. The proverbial equation is as follows: Assets = Liabilities + Owners’ Equity.

The other accounts also follow similar rules.

  • For revenue accounts, a debit will diminish the balance and a credit will boost it.
  • For expense accounts, a debit will add to the balance and a credit will shrink it.
  • For gain accounts, a debit reduces the balance and a credit increases it.
  • For loss accounts, a debit will improve the balance and a credit will lessen it.

Note: If memorising all the rules is not your cup of tea, then you can simply remember that all the debits go in the left column and the credits go in the right one.  

The Rules of Debit And Credit

To understand the rules of debit and credit, you need to keep the accounting equation in mind and understand the following three thumb rules:

  • If the value of accounts on the left side of the accounting equation (i.e. assets) changes, then it will be a debit if the account value increases and credit if the value diminishes.
  • If the value of accounts on the right side of the accounting equation (i.e. liabilities and owners’ equity) changes then it will be a credit if the account value increases and debit if the account value goes down.
  • For every individual transaction, the total amount of debits must be equal to the total amount of credits.

Note: If the debit and credit columns are not balanced, then the record will be inaccurate and will not be accepted by the accounting software your bookkeeping company in Melbourne is using. There are a plethora of other errors that can take place in the accounting system, such as the misclassification of expenses or subsidiary entries. However, your bookkeeper can resolve such issues.

Examples of Debits and Credits

Here are a few examples to better understand the bookkeeping system.

  • If your business in Melbourne has sold a product for $500 in cash, then there will be revenue of $500 and cash of $500. This will be recorded as an increase in the asset account with a debit and an increase in the revenue account with a credit.
  • If you purchase equipment worth $1000 for your business in Melbourne, then there will be an increase in the fixed assets account with a debit and an increase in the liability account with a credit.

Note: You can utilise advanced accounting software for bookkeeping purposes as some of them automatically debit cash when you feed a deposit. Thus you only have to identify the account for credit. Similarly, when you write a cheque, the software automatically credits cash so you only have to determine the account which will receive the debit.   

Conclusion

An entrepreneur in Melbourne must know how debits and credits are classified in the accounting system to ensure they can understand the financial statements. Although your bookkeeper will advise you on financial decisions, you must be clear with the fundamentals to understand the bigger picture. 

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