Understanding credits and debits
Way back, after proudly surviving my first formal accounting classes, I was challenged by a CPA buddy of mine (Tom K) with a mind numbing quiz. If you are so smart Mr. Tim, then let me know, what’s a debit and what’s a credit? I proceeded to launch into a wonderful and lengthy rationalization of debits and credits. When I eventually finished my erudite spontaneous pontification on “debits and credits”, Tom loudly reprimanded me, saying “FLUNK – debits on the left, credits on the right”.
Whether the entry increases or decreases the account is set by choice of the column in which it is entered. Entries in the left column are known as debits, and entries in the right column are called credits. In double entry bookkeeping, at least 2 accounts are impacted by each exchange, one of those entries must be a debit and the other entry must be a credit of equal amount. To complicate things further, more than 2 accounts may be employed if the exchange is split among them, so long as the total of debits for the transaction equals the total of credits. Oddly enough, they must balance (cancel one another out, if you concentrate on it) to 0.
That’s one of the beauties of QuickBooks – the user is spared the choice making process of “what do I enter here…..debit or credit?”. The reality is, whether a debit or a credit increases or decreases an account balance relies on the sort of account. Asset and cost accounts are increased on the debit side – guilt, equity, and cash accounts are increased on the credit side.
QuickBooks obscures the credit / debit facet of transactions, which isn’t necessarily a great thing. That QuickBooks strength may also be a curse. If you do not “grok” the theorem of debits and credits as they apply to particular sorts of accounts, QuickBooks may permit you to merrily enter transactions wrongly. Here’s where the double entry bookkeeping system can help – it offers a system of checks and balances. By adding up all the debits and adding up all of the credits and comparing the 2, differences stick out like a throbbing thumb out and you’ve got the opportunity to correct any errors. When debits and credits don’t match – the “double entry bookkeeping” system loudly tells you something is wrong and wants correction. In reality, QuickBooks will actively stop you from entering “out of balance” (meaning the debits and credits don’t match) transactions.
QuickBooks won’t always prevent you from wrongly alloting debits and credits to your accounts. To avoid bafflement over debits and credits, do not think of them in the way they’re employed in everyday language. You’ll be confused as you thought a credit was a good thing! We learned these terms from working with banks and stores, but they were using the terms from their point of view. When the bank gave you a “credit”, it was their Money they’re crediting, or taking away from. Good for you, not good for the bank. As an entrepreneur, think about debits and credits from your company’s standpoint. When you debit your Money , you add to it. When you credit your Money , you take away from it.
