What are debits and credits?
You may have come across the terms debit and credit and perhaps wondered exactly what do they mean?
Certainly, if you are a bookkeeper or accountant you will or should understand their significance.
The first book on the subject was written by Italian mathematicians in 1494.
Essentially, double entry means that every transaction that can be measured in monetary terms has two effects. For example, if you buy stationery for £25 you incur a stationery cost and reduce your cash in hand. In bookkeeping parlance, stationery costs are debited with £25, cash in hand is credited with £25.
Readers will appreciate that if all transactions can be classified in this way then the total of all debits must equal the total of all credits.
A Balance Sheet is proof that this is the case – total assets (debits) must equal liabilities plus business capital (credits).
So far so good, but why is this important?
Double entry was a useful tool when account’s ledgers were handwritten as it provided proof that all entries made had been considered from a debits and credits perspective.
In some respects, accounting software takes care of the double entry for you. In the above example when you post a cash payment of £25 you will tell the software it is for stationery and when you click enter, the software will make the underlying double entries for you.
Which is unfortunate. Using account’s software does not require that you understand the debits/credits logic, but if you do understand the logic it is a priceless tool to appreciate the meaning and construction of the accounting reports produced.