This is Part 2 in our “All About Bookkeeping” series.
If you missed our first article check it out here:
Now that we have a solid foundation of what bookkeeping is, we want to dig a little deeper.
What are debits and credits and why do they matter?
What is a Chart of Accounts (COA)?
Any prior knowledge you have around debits and credits (usually associated with bank accounts and credit cards) needs to be thrown out. When it comes to bookkeeping the meaning is a little different.
1. What Are Debits vs Credits?
Simply Put: Debit = Left and Credit = Right
- T Accounts: In bookkeeping classes they always start with a “T” account. Basically you take a piece of paper and write a big “T”. If you have a debit it goes on the left side of the line in the “T” and if you have a credit it goes on the right side of the line in the “T”.
- Every Transaction Has Both a Debit and Credit: Every transaction you have uses a minimum of two accounts, at least one account is debited and at least one account is credited. For example, if you buy a package of paper clips you will have a debit to expenses and a credit to your bank or credit card account. Total Debits Must Equal Total Credits
- Accounts That Increase With Debits:
- Owner Draws
- Consequentially these accounts decrease with credits.
- Accounts That Increase With Credits:
- Owner Contributions
- Consequentially these accounts decrease with debits.
2. What Is a Chart of Accounts?
A listing of the account names that every transaction can be coded to.
- Accounts Available for Coding: As we discussed last week, a bookkeeper will take the transaction types we discussed and assign them to their respective accounts (or categories) which is what the Chart of Accounts (COA) is made up of.
- Types of Accounts on COA:
- Assets – Examples: Bank Account, Office Equipment, Vehicles, etc. Assets generally carry a debit balance.
- Liabilities – Examples: Credit Card, Loan Payable, Sales Tax Payable, etc. Liabilities generally carry a credit balance.
- Equity – Examples: Owners Contribution, Owners Draw, Current Year Profit (or Loss), etc. Equity accounts can have both debit and credit balances, depending on the account.
- Income – Examples: Service Sales, Product Sales, Refunds, etc. Income is generally a credit.
- Expenses – Examples: Bank Service Charges, Office Expenses, Payroll Tax Expense, Postage, Rent Expense, Wages & Salaries, etc. Expenses generally are debits.
- Accounting Equation: Assets = Liabilities + Equity
- As we mentioned earlier, every transaction must have both a debit and credit that will balance the equation.
To help better understand debits vs credit and the chart of accounts, lets go through a few examples.
- Receive Income for Services
- If you deposited a check for income you would debit cash (increase cash) and credit revenue (increase revenue). If we look at the accounting equation, cash is an asset and revenue is part of the equity section (P&L) which balances the equation.
- Pay Rent
- You write a check to pay rent, you will credit cash (decrease cash) and debit rent expense (increase rent expense).
- Transfer Money from Business to Personal Account
- This is an example of an owners draw. You would credit cash (decrease cash) and debit owners draw (increase owners draw).
- As you can see with these examples, every one has an account that is debited and also an account that is credited for the same transaction. Every transaction must have both a debit and credit.
- You’ll also notice that the accounting equation balances for each one, Assets = Liabilities + Equity
This article was meant to give you a deeper look into what bookkeeping is. Now that we have learned this part we can dig deeper into bookkeeping and financial statements which we will do in the next article!
This is just the start of our series, be sure to check back for future posts!
If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.