Lesson 5: Double-Entry Accounting &
Debits and Credits
For the sake of accounting and bookkeeping, don't think debit cards and credit cards when I say "Debits" and "Credits." Instead, just think up and down. That is all those words mean in the accounting world. Every transaction has an equal amount of debits & credits and involves at least two accounts. One account goes up (or gets debited or credited) so another one goes up or down (or gets credited or debited) by the same amount. The golden rule works because accounts are debited and credited in a symmetrical manner that ensures both sides of the formula offset (hence double-entry accounting).
It can be kind of confusing conceptually but I'm sure it will make a lot more sense after a few visual Balance Sheet examples:
Debit = Up
Credit = Down
To increase an asset account, a debit entry is made. Conversely, a credit entry decreases an asset account. Pretty simple right?
Example 5-1: You transfer $100 from Checkings to Savings. Here's what that would look like on your Balance Sheet:
Since one a account went up by $100 and another went down by $100, the affect on your total asset value is $0. The affect on your total liabilities and equity is $0 as well because no accounts were used on that side of the formula.
Assets = Liabilities + Equity
($100)+$100 = $0 + $0
$0 = $0
This is double-entry accounting in action! At least two accounts + offsetting Debits & Credits + the golden rule; all requirements are met! As you see, it doesn't matter what side of the formula the accounts and debits/credits fall on. The only thing that matters is the golden formula and the double-entry mechanics.
Now we will incorporate the right side of the formula with a credit card example. First things first, it is important to note that the debit and credit "directions" for liability accounts are exact opposites of asset accounts. For liability accounts:
Debit = Down
Credit = Up
Example 5-2: You use your checking account to make a credit card payment of $250:
Left (Asset) Side: Since your Checking Account decreased, a credit entry of $250 is entered into the account.
Right Side: By making a credit card payment, you are reducing the amount of debt you owe. Therefore, the $250 deduction on the asset side is matched by a $250 debit (deduction) in the liability section. You can accurately map the mechanics behind every transaction as long as you remember:
There must be at least one debit entry to one account and a credit entry to a different account
All debits and credits must offset/equal.
Assets = Liabilities + Equity
($250) = ($250) + $0
($250) = ($250)
It is important to note the differences between the two transactions we have looked at so far. The first one was a transfer between asset accounts, involving two accounts on the same side of the formula. Therefore, we needed 'up' and 'down' entries to ensure balance. Alternatively, the credit card payment did not require an 'up' entry. Balance was gained with two 'down' entries, one on each side of the formula. However, both transactions contained debit and credit entries regardless.
For this reason, you cannot view double-entry accounting as simply "each transaction needing an up and down entry." Obviously that is not true. However, you can view it as simply "each transaction needing to balance the golden rule (or the Balance Sheet)." Sometimes that means two up entries, or sometimes two down entries, and sometimes an up & down entry.
For simplicity, Example 4-1 could easily be described as "Checkings decreased and Savings increased by $100," and Example 4-2 could easily be described as "Checkings decreased and Liabilities decreased by $250" vs using debit/credit language. The seemingly confusing, alternating mechanics of the debit & credit columns, based on where the account resides on the Balance Sheet, is actually the science that drives double-entry accounting. When you are finished with all the lessons of this course you will know exactly what I mean.
The examples in this lesson are only a glimpse into double-entry accounting and the strategic ways that debits and credits (an alternating set of ups/increases and downs/decreases) facilitate the science behind accounting. Continue to the next lesson to dive deeper on debits and credits for asset accounts.