When financial information is recorded the double entry bookkeeping system is used. There is always a debit entry (Dr) and a credit entry (Cr) for each transaction that takes place within the entity. The debit side and the credit side of the transaction must balance therefore, leaving us with a double sided affect, hence the name double entry bookkeeping.
The following examples show debits and credits in action:
A business makes a purchase of a van $1,000. In order to record this transaction we would need to show the reduction of the bank account by $1,000 and the increase of assets owned by the business (the van). This is a double sided effect that influences both the debit and the credit side of the accounts.
The difference between debits and credits, and how to allocate transactions to them will be explained now.
Debits and Credits
‘Debit’ is abbreviated as ‘Dr’ and are always shown on the left hand side when being shown in financial statements. ‘Credit’ is abbreviated as ‘Cr’ and are always shown on the right.
Which side to allocate transactions
The easiest way to memorise where to allocate each side of a transaction is to use remember ‘DEAD’ and ‘CLIC’. The breakdown of these is shown below.
The accounting equation we reviewed in the previous post is now written as;
Capital (Cr) = Assets (Dr) -Liabilities (Cr)
Creating Journal Entries
We are going to use our understanding of debits and credits to create a journal entry for a transaction. Journal entries are the way in which transactions are entered into a nominal ledger. By using the double entry bookkeeping system bookkeepers and accountants have a final check that the transactions they are entering are correct.
Owner introducing £15,000 of capital into the business.
Capital, as we know from CLIP is a credit entry. This is because it is a liability for the company as it is a loan from the owner. We know that for each credit entry there must be a debit entry so we have to analyse what the £15,000 will affect. If £15,000 is entered into the company the bank account will increase by the same amount. We know that an increase in an asset (the money deposited) is a debit entry. This is therefore, the other side of the journal entry.
This would be shown as;
Dr Bank £15,000
Cr Directors Loan Account/Capital Introduced £15,000
Bank Statements often cause a lot of confusion to new business owners as they know that debiting the bank from the point of view of a company increases the bank balance. This however, is not the case when it comes to bank statements. Bank statements are written from the bank’s point of view, therefore, a debit is a withdrawal from the bank as it is the reduction of the liability the bank has to you (or the company). The opposite is true for credit entries which of course, are deposits into the bank account.
When looking at a credit card statement, you will see that repayments often have ‘Cr’ next to them. This is because the credit card (or loan) is a debtor to the bank and a repayment of the credit card is the reduction of the debtor (asset).
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