Basic Accounting: Understanding Debits and Credits

In order to understand accounting systems, knowledge of some basic accounting concepts is necessary.



First, the very basic definition of accounting is a system of recording and summarizing financial transactions in such a way that they can later be analyzed or used to communicate with others.

An even shorter definition: accounting is the documentation of a transaction.

That is it. Not too scary so far...right?

Okay...let’s move on:

There are two basic accounting practices: single entry bookkeeping and double or dual entry bookkeeping

Single entry bookkeeping is an accounting practice that can be employed by small organizations where a profit and loss statement or balance sheet is not required for financial control or tax purposes.

Double entry bookkeeping is an accounting technique to record the financial transactions of an organization where every transaction is entered twice, equal and opposite transactions. Double entry is required for all organizations that must produce both a profit and loss account and a balance sheet.

Double Entry Bookkeeping

First of all, accounting uses 2 basic equations:

1. Assets - Liabilities = Fund Balance (the foundation of all accounting)
2. Debit = Credit (Very important double entry bookkeeping rule! In a transaction - all debits MUST equal all credits.)

Let’s discuss the second one first. In accounting, accounts are set up to look like a “T” and are actually called T accounts –very imaginative huh?

Anyway…in this “T” account – amounts entered on the debit side (left hand side) are called debits and amounts on the credit side (right-hand side) are called credits. 'To debit' means to make an entity in the left-hand side of an account' and 'To credit' means to make an entry in the right-hand side of an account.

Important point! The words debit and credit have no other meaning in accounting. Most people think a debit and credit as a positive or a negative. They are not either.

Now...back to rule number 2...Debits and credits must be equal for all entries in a double entry bookkeeping system.

A debit or credit will either increase or decrease the account balance…depending on what type of account you are working with. This table illustrates the entries that increase or decrease each type of account.

Debits and Credits vs. Account Types:

Notice that for every increase in one account, there is an opposite (and equal) decrease in another. That's what keeps the entry in balance.

Remember…debits always go on the left and credits on the right.

Now to the first equation: Assets - Liabilities = Fund Balance.

or Assets = Liabilities + Fund Balance

What this really means is that, from an accounting perspective, The Fund Balance (also known as Net Worth, Retained Earnings, or Net Assets) is the difference between what you own (Assets) and what you owe (Liabilities).

Your church buys a church van (an asset) for $35,000 dollars. If the church borrowed $30,000 (a liability) and paid the balance with the church’s savings, here is what the accounting equation would look like: $35,000 church van asset = $30,000 van loan liability + $5,000 fund balance (net asset) in the church van.

Learning those two basic concepts wasn’t so hard was it?

Ummm...well...let’s go on to something easier...

Single Entry Bookkeeping

There are advantages and disadvantages of using a single entry bookkeeping system.

The main advantage is the simplicity. It involves the simplest form of keeping records of financial transactions.

Essentially the organization makes two lists, one of income received and one of expenses incurred. This is beneficial for organizations that rely on volunteers with virtually zero accounting or bookkeeping knowledge.

It is essentially like a check register. You credit (right side) your increases and debit (left side) your expenses…all the while keeping a running daily balance. The main disadvantage of single entry bookkeeping is the absence of financial control due to limited detailed records of asset and liability accounts.

It is also easier to make errors with. With double entry bookkeeping everything must balance.

With my single entry spreadsheets...some errors are not found until I do the bank reconciliation.

Want to learn more basic accounting concepts? My eBook Basic Church Accounting provides you with basic accounting concepts, examples of financial statements, and step-by-step instructions for posting church business transactions.

My Free Spreadsheets

I have built my free accounting spreadsheets using the single entry bookkeeping system mainly because our church secretary, whom I built them for, has no accounting knowledge and secondly because the double entry system would be too complicated for me to build and give away.

I believe a lot of small churches and nonprofits rely on volunteer help. A lot of these special people have very limited accounting experience and could benefit from my simple spreadsheets.

As I stated on my "Free Accounting Spreadsheets" page, If you need a double entry accounting system…my spreadsheets might not be the best option for you.

Hope I have not confused you too much.

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