Double Entry is the principle of accounting which requires that every transaction has two effects one of which is a debit and the other of which is a credit of the same amount. What this means is that the total of the Debits must always equal the total of the Credits.
In this example we deposit 10 units of currency into our bank account.
Since the total of the Debits equals the total of the Credits we say the transaction is Balanced.
The Accounting Equation
The Value of the business is the value of its assets less the value of its liabilities and this value belongs to the owners of the business:
The Owners fund must also equal the amount the owners have put into the business (Capital) less any amounts they have taken out (Drawings) plus any profit. For the time being we assume the business is profitable.
We add to both sides to remove the minus signs.
We call items on the left hand side Debits and items on the right hand side Credits. Then:
In order that this equation holds we must also ensure that a loss is on the opposite side to a profit and therefore a loss is a debit.
Note that items of income increase profit so they are also credits, while expenses decrease profit and are therefore debits.
When to Debit, when to Credit?
Another look. Debit (Dr) and Credit (Cr) only refer to which side of the double entry an account/value goes to. Debit on left, and Credit on right. The normal of an account refers to which side it normally increases on, whether it be good or bad for the company.
The D.E.A.D. C.O.I.L. Mnemonic
- Debit side
- Drawing (of Equity)
- Credit side
- Owner's Equity
Debit/Credit-ishness of an account comes from the elements of the accounting equation, Owner's Equity=Assets - Liabilities, and lots of flipping.
Start by looking at the Dr. side.
- If your account is an Equity term, flip it.
- Equity terms are Capital, Drawing, Income, Expenses. These are the financial borders of the business.
- If it's a Liability, flip it.
- Liabilities are negative (well, it's good to have access to resources now, but they still are a hole that demands filling). Remember, if somebody prepaid you for a something you haven't fulfilled, that's a liability too!
- If is an "evil parallel universe" form of an Asset, Liability,or Equity, then flip it (again, if need be).
- Expenses are equity accounts, in a negative way. Drawing is a negative overlay to Capital, and gets flipped here, too. Depreciation (an overlayed contra-asset), flips as well.
- You now know the normal of the account. One last flip if the account needs to be reduced.
Within all of this flipping, Debit/Credit has two meanings, whether a term is negative to the company's finances, and whether it is external to the company. By demanding each entry set to balance, the journal tracks motions of money (or widgets, labor..) in the company. Changes of value are expressed as a motion into yet another account, such as moving part of the "Merchandise" Asset (as Cr) into the "Damaged Goods" Expense (as Dr).
As a mnemonic device for students: Note that only Assets and Expenses show an Increase for Debits and Decrease for Credits. All other accounts are the reverse. First memorize the acronyms AID (Assets Increase Decrease) & EID (Expenses Increase Decrease)and then keep in mind that the table reads Debits on the left and Credits on the right.
|Account||Debit||Credit||Account Debit Credit|
|Assets||Inc.||Dec.||A I D|
|Expenses||Inc.||Dec.||E I D|