| □ | Understanding Debits and Credits - Perhaps you have heard or seen this expression before: |
| • | "Debits must equal Credits" which means the following: |
| • | The sum of all Debit entries must equal the sum of all Credit entries. |
| • | The rules for Debits & Credits (as outlined below) are Rules. |
| • | Just remember them - don't question them until you understand them - and once you do, you won't. |
| • | This may be the most difficult concept for you to understand when first getting involved with an Accounting System - manual or automated. |
| • | The REASON people find this confusing is because initially, it is. |
| • | And this is because the phase "Debits and Credits" is actually used to describe two very different things! |
| □ | The two definitions for Debits and Credits are stated simply and clearly below. |
| ► | Note: We did not make these rules, so don't be angry with us... (a smile is required here, please) |
First, some review (see the "Types of Transaction Accounts" section in the Accounting Terminology chapter for more detailed information):
| ▪ | Asset Accounts 1000 - 1999 - Debit - An Asset Account identifies items that have an actual cash value or can reasonably be converted to cash. |
| ▪ | Liability Accounts 2000 - 2999 - Credit - A Liability Account identifies a portion of what the Company owes, or in some other manner is obligated to pay to others. |
| ▪ | Equity Accounts 3000 - 3999 - Credit - The Equity Accounts identify the net value of the business (Company). |
| ▪ | Revenue Accounts 4000 - 4999 - Credit - These Revenue Accounts identify the Revenue (Income) from Sales, Interest earned from savings, and any other miscellaneous Income. |
| ▪ | Expense Accounts 5000 - 9989 - Debit - These Expense Accounts identify the Purchases made to sustain the business, produce product, complete an installation, and/or provide services. |
| ◆ | The General Ledger Account Numbers 9990 - 9998 are used (internally) by the system and therefore should not be defined by the User. |
| 1. | An Account Type's Classification: (a noun) - The words Debit and Credit are used to classify each Type of Transaction Account: |
| • | Each Transaction Type for an Account (i.e., Asset, Liability, Equity, Revenue and Expense) is designated as being either a Debit Account, or a Credit Account. |
| ▪ | Almost everyone has heard that "Your Debits Must Equal Your Credits". |
| ▪ | This means that the sum of all the Amounts posted to the Type of Accounts classified as Debit Accounts in your General Ledger, must equal the sum of all the Amounts posted to the Type of Accounts classified as Credit Accounts in your General Ledger. |
| • | Therefore, looking at the list above of the Types of Transaction Accounts, you now know that when you add the values in each of the Debit Accounts together (Asset and Expense Accounts) and compare it to the sum of the values in each of the Credit Accounts (Liability, Equity and Revenue Accounts), the total for the Debit Accounts should be the same as the totals for the Credit Accounts - and if not, your General Ledger will be considered "out-of-balance". |
| ▪ | Fortunately for you, the MKMS General Ledger System tracks this "in-balance" issue automatically and assures that your Debits and Credits do equal each other at all times. |
| ▪ | In fact, the MKMS General Ledger System does not accept an out-of-balance transaction, thus preventing it from ever occurring. |
| 2. | An Action performed on a Transaction Account Type: (a verb) - The words Debit and Credit may also represent the action of actually posting Transaction Amounts to any of those Types of Transaction Accounts. |
| • | Is the transaction adding to an account's balance, or subtracting from it? |
| ▪ | When adding to any Account's Balance, the transaction's Action name is the same as the Account Type's Classification. |
| ▪ | When subtracting from the Account's Balance, the transaction's Action name is the opposite of the Account Type's Classification. |
| • | Wasn't that fun? Not really - but the following information will clarify this issue: |
| ▪ | Adding to a Debit Account's Balance is referred to as Debiting the Account (the action of adding to the account's balance takes on the name of the Account Type's Classification). |
| ▪ | Subtracting from a Debit Account's Balance is referred to as Crediting that Account (the action of subtracting from the account's balance takes on the opposite name of the Account Type's Classification). |
| ▪ | Adding to a Credit Account's Balance is referred to as Crediting the Account (the action of adding to the account's balance takes on the name of the Account Type's Classification). |
| ▪ | Subtracting from a Credit Account's Balance is referred to as Debiting that Account (the action of subtracting from the account's balance takes on the opposite name of the Account Type's Classification). |
| • | Continuing with the "Debits must equal Credits" issue, the sum of all Debit entries must equal the sum of all Credit entries. |
| • | This means that you can never make one entry, you will always make a minimum of two (a Debit entry and a Credit entry of the same value) when creating a Financial Transaction. |
| • | By following this "Debits must equal Credits" methodology, the General Ledger automatically stays "in-balance". |
| • | This is what is known as "Double Entry Bookkeeping" (see the related Double Entry Bookkeeping chapter for more information as to why this method is used). |
