Sir Isaac Newton ’s third law of motion, the law of reciprocal behavior, states that for every behavior, there is an equal and opposite reaction. The same can be said about Double Entry Accounting. For each financial transaction, there are two aspects. There are debits and lenders. For each transaction, these aspects must be equal to balance your books.
To understand double-entry accounting, you must first understand what is a debit and what is a lender. In short, the debit is what you own or owe you, and the lender is what you owe others. Let’s take a look at the different account types that companies have.
Assets-These are debit items because they are company-owned items. The increase in assets is a debit and the decrease in assets is a lender.
Liabilities-These are credit items because they are items that companies owe others. The increase in debt is the lender, and the decrease in debt is the debit.
Owner’s equity-this is a credit account, because the balance of the owner’s equity account is the funds owed by the company to the owner of the company. The increase in owner’s equity is the lender, and the decrease in owner’s equity is the debit.
Expenses-These are debits, because purchase expense items reduce asset items (such as bank cash), and the asset item is the lender of the transaction.
Revenue-These are credits, because the increase in income will increase the asset item (such as bank cash), and the asset item is the debit of the transaction.
Let’s look at a simple example:
Suppose you want to go to the store and buy a bottle of milk for $ 3. Your purchase of milk is a financial transaction. Before you enter the store, you own $ 3, so this is a debit item, balanced by the owner’s equity.
When you enter the store to pick up a bottle of milk, you now have a bottle of milk worth $ 3, and you owe the store owner $ 3. Therefore, a bottle of milk is a debit, and the $ 3 you owe is a lender.
When you pay a bottle of milk to the store owner, you are reducing the amount you own (the debit item will be credited) and at the same time reducing the amount you owe (the credit item will be debited).
Please note that in each step of the transaction, the debit and credit of the transaction are equal, and all account balances have equal debit and credit.
So what happens when you drink a bottle of milk? You no longer have a bottle of milk for $ 3. You have an empty bottle, worth nothing! This is why we have expense accounts. Assets are debits and are long-term possessions of enterprises. Fees are also debits and are things the company has for a short time before it runs out.
This is why we have two independent main reports. The balance sheet is used for items that are constant in the business. The income statement (or income and expenditure statement) is used for items that regularly flow into and out of the enterprise. The balance generated in the income statement is put into the capital portion of the balance sheet to balance various situations.
Another report you may have heard about is the trial balance. This is to ensure that you make no mistakes before preparing the balance sheet and income statement. At the end of the accounting period, the ending balance of all accounts (assets, liabilities, owner’s equity, expenditures, and income) will be placed in this report to ensure that the debit and credit are equal. If they fail to do this, you will know that you made a mistake somewhere and need to find your mistake before preparing the main report. The total number of debit columns should be equal to the total number of debit columns.