Debit and Credit are two basic accounting terms that one must understand in order to manage basic accounting in a company. Every time you make some form of transaction in a company, you create a business event. This has two parts:
- Debit shows where money comes in
- Credit Shows where the money comes from
Each business event thus has two sides and this type of accounting that is applied in large parts of the world is called double-entry bookkeeping. The main principle is that in every business event there must be a balance between debit and credit, otherwise you have made a mistake somewhere. If you use a modern accounting program, you will automatically be warned in case there is no balance between debit and credit.
In your accounting, you have different accounts that are either debited or credited depending on what kind of business event is being booked. These accounts can be asset accounts where you add assets such as money, debt accounts where you post debts, income accounts where you post sales and cost accounts where you post costs.
Understanding this logic is a must in order to understand how accounting actually works. The accounting illustrates this logic by dividing the business event into two pages.
|To the left is the debit page where money comes in.||To the right you have the credit side where the money comes from.|
Before you get used to the terms, you can think that in the world of accounting, money flows from right to left.
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Example of accounting for a business event
Let’s take a look at a very basic example of accounting for a business event. Let’s say that your company has sold an item for SEK 1,000. This money goes into your business account. This means that you must first create a credit that shows where the money goes to your company. This is done from account 3010 – sale. After this, you must show where the money ends up in this case through a debit to account 1910 cash. The business event therefore looks like this:
- Credit 3010 1000 kr
- Debit 1910 1000 kr
- Total debit 1000 kr
- Total credit 1000 ISK
If you make a purchase, you must instead take money from your account and therefore create a credit against account 1910 and a debit against a suitable account. An example of this is, for example, payment of rent for business premises that takes place to account 5010. The business event can then look like this:
- Credit 1910 4000
- Debit 5010 4000
- Total debit 4000
- Total credit 4000
Different phenomena in accounting
The four different phenomena that exist in accounting are assets and liabilities (which answer the question of what constitutes a business event) as well as income and expenses (which answer the question of why a business event occurs). Below is an explanation of how these four different phenomena increase and decrease:
An asset increases in debit and decreases in credit: This means that when the cash account , which is an asset account, is to increase, the amount is entered on the debit page – the cash account is debited. If the cash account is to be reduced, you do the opposite and enter the amount on the credit side.
A debt decreases in debit and increases in credit: If a debt account is to increase, you must enter the amount on the credit side and if it is to be reduced, you do the opposite and enter the amount on the debit side.
An income decreases in debit and increases in credit: If an income account such as sales is to increase, you enter the amount on the credit side. If a revenue account is to be reduced, do the opposite and enter the amount on the debit page.
A cost increases in debit and decreases in credit: When a cost is to increase, you post the amount on the debit side and when it is to decrease, you do the opposite and enter the amount on the credit side.
Does double-entry bookkeeping guarantee that there will be no errors?
The simple answer to this is of course no. Double-entry bookkeeping where all amounts of debit and credit are taken out of each other does not guarantee that the bookkeeping does not contain errors. What it does guarantee, however, is that the internal logic of accounting is correct. This means that money never appears out of nowhere or disappears without a trace. Instead, you can always trace where the money comes from and where it has gone. However, errors can of course occur based on logging debit or credit against the wrong accounts or posting incorrect amounts. This in turn can lead to errors in, for example, the company’s VAT report or results.
But even when there has been a mistake in the accounting, the double-entry bookkeeping helps to easily track business events and find inaccuracies. It can also show during an examination that any errors have not occurred due to attempts to cheat.
Another advantage of double-entry bookkeeping is that it is easy for a new accountant or other person to familiarize themselves with the company’s accounting. This means that if you managed the bookkeeping yourself in the beginning and did it correctly, it is very easy for an external bookkeeping expert to take over the bookkeeping work for you without having to start over from the beginning.
How long has double-entry bookkeeping existed?
The system of double-entry bookkeeping has existed since the Middle Ages by Islamic businessmen. The modern double-entry bookkeeping can be traced back to 1494 when the monk Luca Pacioli presented the concept of double-entry bookkeeping in a mathematical work. The fact that this concept has remained virtually unchanged for over 500 years shows that the logic behind the system holds. It can be worth thinking about if you think it feels complicated, once you have understood the logic, it immediately becomes much easier to also learn more complicated accounting concepts