Double entry bookkeeping is accomplished with the accounting equation, Equity = Assets Â– Liabilities or derived as Assets = Liabilities + Equity. The sum of all the debits should be equal to the sum of the credits. In banking, credit refers to deposits and other transactions that will increase your account balance and vice versa, debits refer to withdrawals and other transactions that will decrease your account balance.
Non-accountants often don’t understand debits and credits. “Credit is good but we need cash.” This is usually heard in a conversation between a store owner and a buyer. However, they cannot associate debits and credits with bookkeeping and banking especially if they don’t have formal business establishments and bank accounts.
Why double entry bookkeeping? Double entry bookkeeping evolved in 1494 when Luca Bartolomes Pacioli published his book entitled, Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Everything About Arithmetic, Geometry and Proportion) and in the 36 chapters of this book, he discussed about double entry bookkeeping entitled De Computis et Scripturis (Of Reckonings and Writings). Beforehand, Benedetto Cotrugli wrote Delia Mercatura et del Mercante Perfetto (Of Trading and the Perfect Trader). He included a brief chapter which described many of the features of double entry bookkeeping. This was not published for more than a century and Pacioli was familiar with the manuscript and credited Cotrugli with originating the double entry bookkeeping method.
Double entry bookkeeping is accomplished with the accounting equation, Equity = Assets – Liabilities or derived as Assets = Liabilities + Equity. The equation serves as a tool to detect error. The sum of all the debits should be equal to the sum of the credits. Assets have normal debit balance while liabilities and equity have normal credit balances. However, Double entry bookkeeping does not guarantee error especially if the errors occur with the wrong ledger account or the wrong entry of amount.
The entry of debits and corresponding credits are the features of double entry bookkeeping. Debit does not always refer to an increase of accounts and inversely, credit does not always refer to a decrease. Debit is not always associated to something good and so with credit as something bad. In an accountant’s view, debit is simply the left side and credit is the right side of the equation or the ledger. To understand more about debits and credits in bookkeeping, always remember that:
Debit = value received and
Credit = value parted with
For example, if you received cash from the services you rendered, then the entry to record the transaction using double entry bookkeeping would be:
Debit: Cash as value received
Credit: Service Income as value parted with;
If you pay cash to buy for Office Supplies, the entry in double entry bookkeeping would be:
Debit: Office Supplies as value received
Credit: Cash as value parted with;
And conversely, if you rendered a service without payment yet, the bookkeeping entry would be:
Debit: Accounts Receivable
Credit: Service Income;
The payment receipt will be recorded as:
Credit: Accounts Receivable;
If you purchase Office Supplies on account, the bookkeeping entry in the ledger to record the transaction would be:
Debit: Office Supplies
Credit: Accounts Payable;
The double entry bookkeeping in recording a transaction to pay-off the liability would be:
Debit: Accounts Payable
This is the Accrual Basis Accounting since you record the service when earned as opposed to cash Basis Accounting where you record the transaction as Income as soon as you received the cash payment (the same with the first entry). In Accrual Basis Accounting expense is recorded when incurred as opposed to Cash Basis Accounting that expense is recorded when payment is already made. Thus Accrual Basis Accounting records income when earned even if collection is received or not and expense is incurred regardless if the payment is already made or not.
This is the double entry bookkeeping, but how about banking? Why debits and credits are recorded as opposite in banking as shown in the bank statements. When you received cash from a service rendered, as previously discussed, your entry would be;
Credit: Service Income;
And why does the bank present the Cash deposit in the Credit column in some bank statements? Although some bank statements do not reflect the debits and credits columns but in banking terms, credit refers to deposits and other transactions that will increase your account balance and vice versa, debits refer to withdrawals and other transactions that will decrease your account balance. When a banker says that your deposit will be credited to your account, do not be confused. He means that the entry in the bank’s books would be:
Credit: Depositor’s Account
This is the reason why the banker says that he will credit this to your account because it is the entry in their books. On the other hand, if the banker says that a transaction has been debited to your account, it means that there is a decrease in your account balance. The entry in the bank’s books would be:
Debit: Depositor’s Account
Thus, the decrease in your account balance refers to the debit entry in banks. This the reason why ATM cards also refer to debit cards since these cards are usually used to withdraw cash and purchase items. These activities will result to a decrease in bank account balances. Credit cards are called as such because it will increase your account and the funds came from a loan from the bank. Credit card is widely used since it implies on a positive note than saying debt card but they mean the same. Debt card is not used in order not to be interchanged with debit card because they are similar words. Debit and credit usually go together.
Debits and Credits in double entry bookkeeping have the same concepts in banking. Do not confuse yourself with the terms. In double entry bookkeeping, debits and credits are viewed in a company’s books while debits and credits in banking are viewed in a bank’s books.
Notes: Bookkeeping History