Like any technical field, accounting has its own jargon with meaning that often eludes outsiders. But substantial frustrations descend when you lack knowledge of key terminology deployed in the periphery of your business. An accountant is somewhat like a sports referee conveying an infraction to coaches. That is, describing an observation with shortcut expressions should efficiently reveal the consequences; a time-consuming narrative of complete rulebook passages is unnecessary.
The most crucial element in accounting is that every transaction entails equal offsetting amounts. Simply put, the total of all debits must equal the sum of all credits. Most people have difficulty grasping the terms debit and credit. But understanding the meaning of these words in accounting delivers an improved process for comprehending and resolving errors.
Double-Entry System
You probably think of debits and credits as two separate actions. For example, your bank statement has credits of deposited funds and debits for checks and other withdrawals. In accounting, however, each transaction creates both a debit and a credit. Deposits to your bank account are usually offset by increases in revenue. Most withdrawals are offset by increases in expenses. Recording these increases and decreases is the function of debits and credits.
Increasing revenue with a credit and increasing expenses with debits makes sense. After all, more revenue seems like a credit for working and more expense seems like a debit (or deduction) from your output. The impact on a bank account from revenue and expenses is an offsetting debit or credit. A credit to revenue triggers a debit to cash in bank on your records. Hence, debits on your bookkeeping for a bank account are increases in your cash. Conversely, when you pay a bill – which debits an expense – the offset is a credit on your bank account ledger. Thus, credits on your bookkeeping for a bank account lower the cash balance.
Asset Accounts
Bank accounts in your bookkeeping are assets. Since debits increase the balance on your accounting for a bank account and credits lower the balance, other assets work the same way. Debits increase the ledger balance for an asset and credits reduce it. Buy a new computer and you debit the asset account for equipment. The check you write to the computer store is an equal amount of credit to the bank account ledger on your books.
Liability Accounts
What about purchases with borrowed money? You still debit an expense or asset, but the offsetting credit is to a liability account instead of the bank account. So a credit to liabilities – such as a credit card or loan – increases the balance on the ledger. How come those credits are increases but the credits to a bank account are decreases? The bank account, remember, is an asset. Credits decrease assets; credits increase liabilities.
And don’t forget the reverse affect of debits – they increase assets but decrease liabilities. So what happens when you pay off a credit card by writing a check? Simple. Debit the credit card liability account (which decreases the balance) and credit the bank account (it’s decreased too). Two decreases? No wonder we need to start thinking of offsetting double entries as debits and credits instead of increases and decreases.
The Finance Writer 