Financial Accounting is a new terrain for me. What account do I debit, or credit?
I’m not an accountant :-) My background is in Software Engineering, venturing into Entrepreneurship means getting a hold of my businesses’ financial accountability, hence I decided to apply into the CORE program at Harvard Business School, Online.
The concept of credits and debits was a bummer, it took me over 4 hours to finally grasp this concept. This set me off to really comprehend how all the other financial accounts play together.
Let me explain.
Fundamentally, Assets = Liabilities + Equity.
To really grasp DEBITS and CREDITS, we need to break down this equation and expand on what Equity really is.
Equity = Owners’ Contributions (Owners’ Equity) - Dividends + Retained Earnings
Furthermore, we’ll have to expand on what Retained Earnings are, i.e. Profits. Retained Earnings (Profits) = Revenues - Expenses.
Now, factoring this into the equation, you get that.
Equity = Owners’ Equity — Dividends + Revenues — Expenses
Now we know what Equity really is, we can re-factor Equity into our original equation, i.e. Assets = Liabilities + Equity.
Assets = Liabilities + Owners’ Equity - Dividends + Revenues - Expenses
Mathematically balancing this equation, by moving all the negative components from the RHS to the LHS, you’ll have that:
Assets + Dividends + Expenses = Liabilities + Owners Equity + Revenues
The LHS of the Equation is the DEBIT side of life, and the RHS the CREDIT side of life.
This means that in other for you to indicate an increase in, let’s say an Expense account (Deferred Expense is not an expense :-) ), you’ll have to DEBIT that account.
Similarly, to indicate an increase in a Liability account, you CREDIT that account.
The converse applies for decreases.
This has changed and reprogrammed my understanding of CREDITS and DEBITS from meaning good or bad or increase or decrease to a transfer of economic value from source to destination.
I really hope this helps, feel free to share your insights on this topic.
Love and light, always!
