One of the main challenges many encounter when delving into accounting in Australia is grasping the concepts of “debit” and “credit”. In this article, we’ll explain debits and credits in a way that makes it easier for you to understand.
Every financial event, or transaction, must be entered on two accounts: one with a positive amount (debit) and another with a negative amount (credit). This is done to indicate where values were placed and where they were sourced.
Most people use plus and minus as terms to make it easier to understand debit and credit. It’s a simple way to understand these more easily. However, we acknowledge that working with accounts may be difficult, so don’t worry if you don’t understand it immediately!
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Debit, credit and types of accounts
How an amount is recorded as debit or credit affects the accounts in the ledger differently depending on the type of account. There are various account types, some for assets, some for liabilities, and others for different expenses and revenues.
Recording an amount with a positive sign (debit) is done when:
- An asset increases in value
- An expense rises
- Liabilities decrease
Recording with a negative sign (credit) is done when:
- Liabilities increase
- Revenue rises
- An asset decreases in value
Feeling confused? Let’s take a closer look.
It might seem odd at first, but in accounting, we sometimes use positive numbers for expenses and negative numbers for revenue.
Consider this example:
When your company purchases a mobile phone and pays with a company card:
- 600 Australian dollars on account 13100 Computer Equipment (debit)
- 600 Australian dollars on account 11000 or another bank account (credit)
The two amounts balance, ensuring that the ledger “checks itself.” We can see where the money came from (bank account) and what it was spent on (computer equipment). In other words, the bank account was credited (reduced) while your expenses increased because you bought a computer (computer equipment).
Are you keeping up with the explanation so far?
Now, let’s examine your company’s bank account. When a customer pays your company through a bank transfer, the bank account naturally increases. Therefore, a negative amount must be recorded somewhere, often on an income account, e.g., account 3000 Sales Revenue.
- 200 Australian dollars on bank account 11000 (debit)
- 200 Australian dollars on sales revenue account 11200 (credit)
These were revenues generated from the sale, and when the customer settles up, and the money actually appears in the account, it is registered in this manner.
In accounting, mastering “debit” and “credit” within the double-entry system is crucial. Simplified with terms like “plus” and “minus,” debiting increases assets or expenses, while crediting boosts certain liabilities or revenue. As you delve further into the world of accounting, the understanding of these concepts will become more intuitive and essential for effective financial management.