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Debit and credit: What they are and how they work in accounting

Debit and credit are fundamental terms in accounting. They represent the two main columns in which financial transactions are recorded in the accounting records. These terms are essential for keeping a balanced record and understanding the financial position of an entity.

1. What are debits and credits in accounting?

Debit and credit are essential pillars of financial accounting, and their correct understanding is crucial to properly record the financial transactions of any business entity. Understanding these basic accounting principles is essential for business owners and entrepreneurs to maintainoptimal financial management. Debit and credit remain central concepts in financial accounting, and their mastery is essential for anyone involved in the management of a business.

Debits document incoming transactions, while credits document outgoing transactions. Debit entries are made in the left-hand column, credit entries in the right-hand column. A debit entry is considered a debit and a credit entry a credit.

1.1 Debit

The term “debit” comes from the Latin “debere”, meaning “to owe” or “to owe”. In the accounting context, the “debit” is one of the two fundamental pillars of the double-entry bookkeeping system, the other being the “credit” or credit.

1.1.1 Location in the accounting ledgers

In the accounting records, the “debit” is always located on the left-hand side of an account. When we speak of “debiting an account”, we mean making an entry on the debit side of that account.

  • Function in Transactions: The “debit” is used to reflect increases in certain accounts and decreases in others. Specifically, it is used to record:
    • Increases in asset accounts. For example, when a company buys machinery for cash, the machinery account (an asset) is debited and the cash account is credited.
    • Increases in expense accounts. If a company incurs an expense, such as wages, the wages expense account is debited.
    • Decreases in liability accounts. When a debt is repaid, the corresponding liability account is debited, indicating a reduction in the debt.
    • Decreases in income accounts. Although less common, there may be situations where a previously recognised revenue needs to be adjusted or reversed .
  • Credit relationship: In the double-entry accounting system, every debit (debit) in a transaction must be offset by a credit (credit) of equal value. This ensures that the accounting equation Assets: Liabilities: Equity remains in balance.
  • Importance in accounting:
    • The “debit” is essential for tracking and recording changes in an entity’s accounts. It allows companies to keep a detailed record of their transactions and to ensure that their financial statements are accurate and complete.
    • In addition, the proper use of the “debit” and its counterpart, the “credit”, ensures that the books of accounts are balanced, which is fundamental to the integrity and reliability of financial information.

In short, the “debit” is a crucial accounting tool which, together with the “credit”, allows companies to record, track and report their financial transactions in a systematic and structured manner. It is essential for maintaining the accuracy and completeness of financial records and for providing reliable financial information to the company’s stakeholders.

1.2 Credit

The term “credit” in accounting refers to one of the two essential components of the double-entry accounting system, the other being the “debit”.

1.2.1 Location in the accounting ledgers

In the accounting records, the “credit” is always located on the right-hand side of an account. When mentioning “crediting an account”, reference is made to making an entry on the credit side of that account.

  • Function in Transactions
  • The “credit” is used to reflect increases in certain accounts and decreases in others. Specifically, it is used to record:
    • Increases in liability accounts. For example, when a company takes out a loan, the loan account (a liability) is credited.
    • Increases in capital accounts. If an owner invests more money in the company, the owner’s capital account is credited.
    • Increases in revenue accounts. When revenue, such as sales, is recognised, the sales revenue account is credited.
    • Decreases in asset accounts. When paying cash, the cash account is credited, indicating a reduction in this asset.
    • Decreases in expense accounts. Although less common, there may be situations where a previously recognised expense needs to be adjusted or reversed .
  • Debit Relationship

In the double-entry accounting system, each credit (credit) in a transaction must be balanced by a debit (debit) of equal value . This ensures that the accounting equation Assets: Liabilities Equity remains in balance.

  • Importance in accounting
    • The proper use of the “credit”, together with its counterpart, the “debit”, ensures that the accounting books are balanced, which is essential for the integrity and reliability of financial information.
    • The “credit” is essential for recording and tracking changes in an entity’s accounts. It helps companies to keep a detailed record of their transactions and ensures that their financial statements reflect a true and fair view of their financial position.

In short, the “credit side” is a vital accounting tool which, in conjunction with the “debit side”, enables businesses to record, monitor and report their financial transactions in a consistent and structured manner. It is essential for maintaining the accuracy and completeness of financial records and for providing reliable financial information to the company’s stakeholders.

2. What is double entry?

The double entry rule is a fundamental principle in accounting which states that for every financial transaction that is recorded, there are at least two effects on the accounting accounts, and the total value of debits (debits) must equal the total value of credits (credits). This rule ensures that the basic accounting equation remains in balance.

The accounting equation is: Assets: Liabilities Equity.

  • Transaction: A company borrows $10,000.
    • Debit (Debit): Assets (Cash) are increased by $10,000.
    • Credit: Increases liabilities (Bank Loan) by $10,000.
  • Both debit and credit add up to $10,000, thus balancing the books.

The double entry rule is essential because:

  • It maintains the integrity of the accounting records: It ensures that there is always a complete record of all transactions.
  • Itprovides a control structure: If at any time the total of debits does not match the total of credits, it indicates an error in the accounting.
  • It reflects the dual nature of each transaction: Each transaction affects at least two accounts, which helps to provide a complete picture of financial activity.

In short, the double-entry rule is the basis of modern accounting and ensures that financial statements provide an accurate and balanced representation of an entity’s financial position.

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3. How to draw up a balance sheet?

The balance sheet, also known as the balance sheet or statement of financial position, is one of the main financial reports of a company. It provides a snapshot of the entity’s financial situation at a specific point in time, showing its assets, liabilities and capital. Here are the steps to prepare a balance sheet:

  • Gather the Information: Before you begin, make sure you have all financial information up to date and at hand. This includes all transaction records, accounts, subsidiary led gers and any other relevant financial reports.
  • Design the Header: The header should contain the name of the company, the title “Balance Sheet” or “Statement of Financial Position” and the date of the balance sheet.
  • List the Assets: Assets are everything the company owns. They are generally classified into:
    • Current Assets: Those that are expected to be converted into cash or consumed in the short term (e.g. cash, accounts receivable, inventories).
    • Non-current assets: Those that have a longer useful life and are not expected to be converted into cash in the short term (e.g. property, plant, equipment, intangibles).
  • List Liabilities: Liabilities represent the debts and obligations of the company. They are classified into:
    • Current liabilities: Debts and obligations that are expected to be paid in the short term (e.g. accounts payable, short-term loans).
    • Non-current liabilities: Debts and obligations maturing in the long term (e.g. long-term loans, pension obligations).
  • Determines Stockholders’ Equity: Stockholders’ equity represents the owners’ investment in the company. It is calculated as:
    • Stockholders’ Equity: Total Assets – Total Liabilities.
    • It can also be broken down into components such as share capital, reserves, retained earnings and, if applicable, other equity accounts.
  • Verify that the Balance Sheet Fits: The sum total of assets must equal the sum of liabilities plus stockholders’ equity. This is a manifestation of the basic accounting equation: Assets: Liabilities: Stockholders’ Equity.
  • Check and Adjust: Once you have listed all the items, check the figures to make sure that everything is recorded correctly. You may need to make adjustments based on recent events or corrections.
  • Finalise: Once you are satisfied with the balance sheet, it is advisable to have it reviewed by an accountant or auditor to ensure accuracy and compliance with applicable accounting standards.
  • Presentation: The balance sheet is generally presented as part of a company’s annual financial statements, along with other reports such as the income statement and cash flow statement.

Preparing a balance sheet requires accuracy and attention to detail. It is essential to ensure that all transactions are recorded correctly and that all accounts are up to date.

4. How can technology improve accounting management?

Accounting management has undergone a significant transformation with the introduction of technology. Technological solutions not only make accounting easier, but also more accurate, faster and more efficient. Tickelia, a solution for managing business expenses, has the functionality to be incorporated into the company’s ERP and also supports greater accounting control of expense notes.

  • Automation of accounting entries: The solution can differentiate between payments made through payroll and those made by bank transfer. This distinction is crucial for maintaining accurate records and complying with tax and labour obligations.
  • Bidirectional Integration: One of Tickelia’s most outstanding features is its ability to integrate bi-directionally with other technology solutions, such as ERP (Enterprise Resource Planning) systems. This integration allows data to flow seamlessly between Tickelia and other systems, maximising process automation and ensuring that information is synchronised across all platforms.
  • Real-time Expense Management: With Tickelia, companies can track and manage travel expenses in real time. This not only facilitates expense approval and reimbursement, but also provides managers and accountants with a clear and up-to-date view of company expenses.
  • Reduced Fraud and Errors: By automating expense management and having a system that verifies and validates expenses, the risk of fraud and errors is significantly reduced. This ensures that expenses recorded are legitimate and supported by proper documentation.
  • Mobile Access and Flexibility: Modern technology solutions, such as Tickelia, often come with mobile applications that allow employees to record and submit expenses on the move. This speeds up the reimbursement process and ensures that expenses are recorded in a timely manner.

In conclusion, technology has revolutionised the way companies manage their accounting and expenses. Solutions such as Tickelia not only simplify and automate processes, but also provide tools for more efficient and transparent management of travel expenses. Companies that adopt these technology solutions are better positioned to keep accurate records, comply with regulations and make informed decisions based on real-time data.

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Marta Romero
Content writer at Inology.
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