Accounting Basics: Debits and Credits Explained

This article will explain what Debits and Credits are, define them, and show you why this. It is going to help you out. Exciting stuff? Are you ready? Let’s do this. And understand the Debits and Credits properly. 

We think it’s important to make a couple of points clear to remove any misconceptions. Debits and Credits are neither good nor bad. Debits and Credits are not the same as adding or subtracting. Debits and Credits are words used to reflect the duality or double-sided Nature of all Financial Transactions. If you need an analogy to help you visualize this, you can think of Debits and Credits as Heads and Tails on a coin since there are equal and opposite sides to every transaction. In the world of finance, money doesn’t magically appear or disappear. For the money we to go to one account. It has to come out from another accountant. Consider every transaction to involve a flow of “ Economic Benefit, ” from a source to a destination. 

What is Economic Benefit? Economic Benefit is the potential for an asset to contribute, either directly or indirectly, to an entity’s cash flow. We said that accountants consider every transaction to involve a flow of economic benefit from a source to a destination. Well, credits represent the source, and debits represent the destination. Destinations that economic benefit can flow to include assets like cash buildings and Amounts Owed to you by others and Expenses. A business pays a third party for a good or service they have been provided. And dividends where a business distributes some of its cash to its owners. On the other hand, sources that give economic benefit can flow from the owner’s equity, where business owners give their cash to the business. The liabilities such as amounts owed to a bank in exchange for a loan or to suppliers for providing a good or service. 

So let’s bring back up that accounting equation, and I’ll prove this to you – Assets, equal Liabilities, plus equity. Now we know that Debits and Liabilities represent assets by credits. However, Equity is a tricky one to understand properly. We have to expand it into the components that make it up. Now for disclosure here… we’re about to do some maths. Don’t be afraid we’re just going to do some simple rearrangement here. If maths isn’t, your thing maybe read this next section through a couple of times, so you can wrap your head around it. You’ll be okay. Equity equals owner, equity, paid in fewer dividends, paid out plus retained earnings. Well, Profit is made up of Revenue fewer Expenses. So let’s replace Retained Earnings in our Accounting Equation. With revenue, fewer expenses. We have… Equity equals Owner’s, Equity, paid in fewer Dividends, plus Revenue, fewer Expenses. And now, let’s take this definition of Equity and break it out in our Accounting Equation: Assets, equal Liabilities plus Owners, Equity, paid in fewer Dividends, plus Revenue, fewer Expenses And finally, let’s do a little rearrangement, so we have… Dividends, plus Expenses plus Assets, equal Liabilities. Plus Owner’s Equity paid in plus Revenue. The left-hand side represents Debits. These increase when Debited and decrease when Credited. The right-hand side is the opposite. These are Credits. These increase when Credited and decrease when Debited.

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