Probably the aspect of accountancy that most people struggle to come to grips with is the thing known as the Double Entry System. Those debit and credit entries – knowing what to debit and what to credit and when to do so. Knowing how to make adjustments, knowing how to interpret debit and credit balances, being able to draw T-accounts to plan entries and, after all is done, to read and interpret a Trial Balance, Income Statement and Balance Sheet.
We take the building blocks of accounting one step further this week after exploring the Chart of Accounts and the Trial Balance (Post Boxes for the types of transactions your business will have or has) by delving into the workings of each account you have opened.
Each account – Bank, Rent, Salaries, Stock, Interest Received, etc. has a left and a right side. This left and right side are the two sides created under the Capital form of the letter T, hence T-accounts.
The left side is the Debit side and the right side the Credit.
There are many ways people try to remember this – at school we tried D for debit and D for door when the door to our accounting class was to the left of the room. This however did not work the next year when in a class with the door to the right. Just learn it. Debit is on the left and Credit on the right.
The Double Entry system simply means that for each transaction captured in your General Ledger – the book containing the accounts (boxes) you need in order to track your business dealings – one entry must happen as a debit entry in one account and a corresponding credit entry must happen in another account for each and every entry. A debit in one T and a credit in another T.
To make this as easy as possible, I am going to concentrate this entire blog on the account we call Bank. This account must mirror everything that goes through on your actual bank statement you receive from your banker.
Two things you need to learn today:
- Debit is on the left and credit on the right.
- Money in the bank is a debit balance in your General Ledger account and an overdrawn or an account in overdraft will have a credit balance in your General Ledger account. (Later we’ll learn that all Assets, of which a favourable bank balance is one, will have debit balances.)
To make sense of the Double Entry, the easiest way is to see your bank account as a central hub for transactions – money coming in through cash sales or people settling their accounts and money going out in the form of payments to suppliers, staff and operating expenses.
In your Chart of Accounts you will thus have an account for Bank and then for everything that will result in money coming in and for money going out. Money in to your account is a debit and money going out (reducing your asset) is a credit. If at any stage you forget this, open up your bank statement – your banker captures everything opposite to you in their books – hence the need to mirror. On the Bank statement money in is a credit – you mirror your bank statement by debiting your General Ledger account called Bank for money in.
Back to our General Ledger entries and the Double Entry System.
When we pay money out it is a credit (learn this). Now the corresponding entry must be a debit. What is being paid? If the money is going to your Landlord, then the corresponding debit will be to Rent. If the money is going to Salaries, then the corresponding debit will be to Salaries. Two entries – one debit, one credit – all you have to learn is that money coming into your Bank is a debit and money going out is a credit in the account named Bank.
If money comes in then we debit Bank. It is your money now – it is your Asset. We are not done until the Double Entry has been made. This time we need to place the corresponding entry in another account as a credit.
So where did the money come from?
A cash sale – then credit Cash Sales for the particular product or service. From someone who owed you money – then credit Debtors and in particular the one who paid you. Interest you received from an investment – then Interest Received and in particular the account (box) you opened for the particular investment e.g. 30-day Notice Account.
Most transactions in a small business involve the movement of money either in or out of your business. By learning what happens in the Bank T-account, the Double Entry becomes easy to establish.
Play with this for the next week and you should be ready to take this basic understanding of T-accounts and the Double Entry System to the next level.
- Print your Bank Statement from your Banker.
- See that money in is reflected as a Credit on this statement.
- See that money out is reflected as a Debit on this statement.
- Know that your Bank account in your General Ledger mirrors these movements – changes them around – like reading a word in a mirror – a Credit on your bank statement is a Debit in your General Ledger and vice versa.
- Now visualize your own Bank account – money in; an Asset to you – a debit.
- Money out a credit.
- Lastly visualize the corresponding entry to make up the double. Who is it from or where did it go?
By Louis Gerke
Development Facilitator – The Ripple Effect
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