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Debits and Credits

People are confused by debits and credits

A lot of people (approximately all people who are not accountants!) don’t understand debits and credits. I suspect even many professional book-keepers and accountants just memorise some rules. It’s easier than trying to understand things, especially when many explanations are difficult to understand, or just plain wrong.

There is no need to be confused, and no need to memorise anything

You don’t need to memorize which accounts are negative and which are positive. Just relate them to the English words ‘debtor’ (someone who owes money) and ‘creditor’ (someone who is owed money), and you can work out the right entries for any transaction.

You credit (CR) an account when you’re recording:

  • an increase in the amount your company owes, or
  • (equivalent) a decrease in the amount some other entity owes your company

The other entity could be a supplier, a customer, or one of your own shareholders. Shareholders are just like creditors, except that they’re last in line.

Examples of credits that can be identified by the above rule:

  • A customer pays you some money they owed you: CR Assets - Accounts Receivable
  • A supplier sends you an invoice: CR Assets - Accounts Payable
  • You send an invoice to a customer: CR Revenue

The last example might be confusing at first. Why is revenue like something you ‘owe’ someone? Because any profit the company you make does not really belong to the company, but to the shareholders.

If you can work out whether one side of a transaction is a debit or a credit, you know the other side is the opposite. So, for the above transactions:

Assets - Accounts Receivable Cash
Assets - Accounts Payable Expenses
Revenue Assets - Accounts Receivable