Understanding Debits and Credits

Do you find yourself frustrated, wondering whether to debit or credit a nominal ledger “T account”?

Or maybe you know to debit or credit a particular account because you’ve done it so many times that it is now instinct, but do not understand why you are debiting or crediting that account.

And if asked, could you explain why a debit entry in the bank “T account” records money going into the bank account, but on the bank statement it’s a credit entry?

If you are struggling, let me help you! I am an AAT bookkeeping and accounting tutor.

I’ve been there! I’ve known your frustration. You feel you will never understand this bookkeeping “language”. I’m here to tell you that, with a little support, you will! You too can understand debits and credits. In fact, you can become so confident, you can teach others.

Why do we use debits and credits?

Debits and credits are ways of expressing changes in the accounting equation. You may even have heard the equation ASSETS minus LIABILITIES equals CAPITAL.

This means what a business owns (assets such as property and equipment) minus what it owes to others (obligations such as loans, mortgages), leaves the capital (or equity) that the owners have in the business.

Here’s an example:  If you own a house that is worth say £300,000 (asset), but you have a mortgage (liability) outstanding on the house of £140,000, then you have equity in the property of £160,000. In other words, if you sold the house and paid the mortgage, you would have £160,000 in your bank, and that is yours to keep.

Over time, the value of the house, the mortgage and the equity will change. This change will alter the accounting equation.

Well, a business is the same. Businesses have assets, liabilities, and the difference between the two is the capital/equity which is owed back to the owner.

The accounting equation for a business will change after every single transaction. Sales, purchases, expenses, depreciation of assets, owner’s drawings/dividends will all alter the equation. Every transaction will impact the equation. Debits and credits are the tools we use to record how the equation is impacted.

In a future blog I will explain how to use this debit and credit “tool” and why it works.

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