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Thursday, April 3, 2014

Accounting Basics - Introduction to Debit and Credit

For a common man who didn't ever study formal accounting, the terms credit and debit can be quite confusing. When depositing X money in your bank account, the teller tells you," You account is credited by X dollars," but while you withdraw money Y from your account, the teller informs you," Your account is debited with Y dollars." It is important to understand the difference between these two, as everybody today makes use of credit cards and debit machines.
However, whatever you may have known about these words needs to be forgotten, because in the language of accounting, the term debt describes a bank account while the money the bank owes to its clients is credit.
In accounting language, neither debits nor credits are 'bad', as the two must be equal to each other and balance themselves finally at the end of any calculation. For every recorded transaction, whether it is a paid bill or an amount deposited, in the system of accounting there need to be two entries, one each for debit and credit. This system of accounting is known as a 'double entry system.' So, when the teller at the bank says he is crediting X dollars to your account, he is simultaneously creating a debit entry for the same amount X, though you are not informed of the debit entry. Likewise, when the teller debits your account by Y dollars, a credit entry for the same amount is created elsewhere.
The simplest way to understand credits and debits in accounting language is to know what you collected and from where it came. In the language of an accountant, what you collect is debit, whereas credit is from where you got it. For example, you purchased a TV, using your credit card. The TV is what you collected, meaning it will be debited in the accounting world, while the credit is reflected by the liability created in the credit card by an exactly similar amount.
Your dealings with the bank may be quite confusing as far as these two terms are concerned. This is especially true when we are talking about liabilities. In fact, it is not all that difficult to understand. For example, when you deposit money in your bank account, the liability of the bank towards you increases by the amount you deposited, as the bank owes you the amount deposited. Now, all liabilities are credits. So, the bank credits your account by that much money. On the other hand, when you withdraw money from the bank, you are reducing the bank's liability, so the bank debits the liability account.
Basically, you should have a clear understanding of what you collected and from where it came. Once you can understand these two for any transaction, you won't go wrong in interpreting these two most frequently used accounting terms.
Would you like to discover more accounting information?

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