Hello in this presentation we will discuss debits and credits. Objectives at the end of this we will be able to define debits and credits list account normal balances and explain how debits and credits work. First we want to take a look at the double entry accounting system and recognize that the double entry accounting system can be represented in multiple different ways including as we have seen before the accounting equation meaning that assets equal liabilities plus equity, we can record transactions using this accounting equation as we have done in the past. That accounting equation is the basis behind the balance sheet where we have the assets liabilities and equity representing the fact that the balance sheet then would be in balance.
Therefore, if the accounting equation is in balance, then the balance sheet would be in balance, the balance sheet being in balance. Another way of saying that the accounting equation is in balance. We are now going to move to the third way of looking At the double entry accounting system to see that it is working, and that same balancing concept will be represented with the idea of debits and credits. When we move to debits and credits, oftentimes when learning accounting, we often learn the accounting equation first, because it’s a nice simple equation and equations are something we have all seen before, then we typically take a look at the financial statements. Before we start to creating the financial statements with debits and credits.
After having looked at the double entry accounting system in terms of the accounting equation, it’s very natural to then ask why are we moving to debits and credits? When I completely understand this accounting equation over here and how to record transactions within the accounting equation and plus the balance sheet and all the the financial statements do not have debits and credits in them? What then is the point of learning debits and credits? To answer that question, I would compare debits and credits to something like that. building a house with a screwdriver versus an electric screwdriver in that the debits and credits when we build the financial statements, we could actually build the entire financial statements using the accounting equation, but it’s a lot more bulky if we if you’ve looked at some of those extended formats of the accounting equation, it’s a lot more bulky to use than debits and credits, debits and credits are going to streamline the process, they’re going to make it easier for us to compile data and put that data into a format that can more easily be converted into financial statements.
So if we’re working on any substantial level, with financial statement creation and the accumulation of data and trying to set up how that data should be accumulated, it’s a lot more efficient to use debits and credits than the accounting equation. So any any type of accounting beyond a certain point you have to learn debits and credits. It’s just something you have to do. And in order to learn debits and credits, we just have to memorize them in order to use that tool. Just The basis of using this tool means that we have to learn debits and credits a new concept, a concept that is not just an equation, an equation being math that we’ve seen before, but new terms with new definitions that we just have to memorize, just as we would memorize a game. So whenever we learned something new, even if it can be an enjoyable thing, and accounting can be an enjoyable thing just to move these numbers around in a similar way as playing checkers.
But in order to play the game of checkers, we have to move we have to know where the pieces go on the board. The same is gonna be true for the debits and credits, we need to know where the pieces go. There’s no way to get around the fact that you just have to memorize that. It’s the same for something like music, we have to learn scales or we have to learn just how to memorize a few songs at first in order to play them, or how those notes get together put together in some way. In order to play music. You just got to memorize that before you can move on to actually work in With those those tools. So in order to do that, what we’re going to do is just like the checkerboard here, we’re going to put our pieces on the board, our pieces are going to be the account types. Now, these are not the actual accounts because for example, within cash within assets, we have like cash, accounts receivable supplies, but these are the account types.
And within those account types, we can see what’s where they’re going to line up in terms of the board in terms of the board of debits on the left, credits on the right. So remember that terminology, all we’re talking about in terms of debits and credits mean that this is our plane board, and the debits will be on the left of that plane board. The credits are on the right of that plane board. Any other definition any other preconceived notions you have of debits and credits, we need to get that out of your mind. And just think about the idea that debits on the left credits on the right credits do not mean increased or decrease debits and credits are not inherently good or bad. And many of us have preconceived notions in terms of What debits and credits are because of terms like credit cards, or talking to our bank, when they are going to credit our account or something like that debit cards give you what you want to remove all those kind of things from your mind.
We can talk about later how those terms derived from the original term, which is basically just nothing more than just just like the pieces on a checkerboard debits going on the left credits on the right, and look at the origins of those terms and how we can better think about them in our minds when we deal with them in real life. But for now, we’ve got to put those ideas of what debits and credits are separate use them in our day to day life as we need to. And keep this definition as we work with financial statements as debits or just on the left credits or on the right. Then we just need to line up our pieces on the board in accordance with the set of rules. These are just the rules just like the rules to set up a checkerboard meaning assets are going to be debit normal balance accounts. liabilities are going to be credit, normal balance accounts, equity is going to be a credit normal balance account. In terms of the accounting equation, that’s all there is to it.
You just got to memorize that and you got to have the cheat sheet in front of you as you work through transactions as you work through transactions with a cheat sheet. You’ll start to memorize this if you’re applying the proper kind of thought process, which we’ll talk about later. So that of course, is the accounting equation here assets equal liabilities plus equity can be represented basically as assets being on the left side of the T account or debits, and liabilities and equity being on the right side of the T accounts or credits. It is also our going to be our balance sheet. Notice the entire balance sheet is this assets equal liabilities plus equity. So we can think of the balance sheet and the accounting equation and the debits and credits all in the same way. In some cases in this format. Then we’re going to have the income statement which throws a little bit of a twist into our accounting equation. In here, the income statement including revenue, which has a normal credit balance, and expenses, which have a normal debit balance, these are going to be the income statement accounts.
Note that revenue and expenses only go up meaning clients only pay us. So it’s only going to increase or customers only pay us. And we only pay expenses like the utility bill, or wages and whatnot. That utility company doesn’t pay us. The employees don’t pay us it only goes one way the transactions only go one way. Now the tricky thing here is the fact that revenue and expenses note are not part of the accounting equation, assets equal liabilities plus equity. And you might remember from working with the accounting equation, that every time we were doing something with revenue and expenses, we included that in the equity section. And the reason is that the entire income statement is in a way, part of equity. It’s going to be one component of the equity sections, kind of like the timing mean that’s happening within the equity section.
So over a certain time period, unlike when we just record things to say, an asset account like cash, where we just put everything to the cash account, the equity account, we break things out between, for example, the owner’s equity that draws revenue and expenses. So when we think of equity as one account, then as one lump sum kind of number one hole, we have to take into account the entire revenue and expenses. This is one of the most confusing things. When we think about this, this part here, when we think about the normal debits and credit is this relationship between the income statement accounts revenue and expenses and the equity accounts. Another thing people typically get confused on is the difference between revenue and assets, particularly cash in revenue. Those are two different things. Notice that cash assets have a normal debit balance. Revenue has a normal credit balance.
You can think of that Kind of as an idea that most journal entries are, you know, good or bad, meaning if we did work and we earned revenue, then we’re going to, we’re going to debit cash and credit revenue. There’s nothing bad about that journal entry, everything’s good. If we did work and we got money, everything’s good, but we still need a debit or credit, that’s gonna be a debit to the asset and a credit to the revenue. So there’s nothing inherently good or bad, therefore about debits and credits. Another piece that people get confused on is the relationship between expenses and liabilities. Because these are the two things that we don’t typically like. And again, liabilities are credit up here, and their expenses are going to be debits. And we can we can think about something we don’t really like to do possibly paying the utility bill with cash or pan utility or incurring a bill and currently utility bill and not paying it so we’ve accrued the bill that we owe in the future, we would credit the liability payable and we would debit the expense. There’s nothing good about that journal entry is nothing good about us. In a bill, and although we obviously we consume the utilities to help make money, that’s good.
But the fact that we incurred a liability and are recording an expense, none of those are good. And we need a debit and credit in order for the debits and credits to be equal. And so that’s one way we can kind of think through this. Let’s just go through these normal balances first again. So the normal balances, you just got to memorize or have this cheat sheet, we’ve got the assets on the left, liabilities on the right, equity on the right of our board over T account, just have to memorize that. That is the accounting equation. That is the balance sheet. Then we add to it the income statement, that being revenue on the credit side, debit amin expenses on the debit side, that is the income statement. And then you want to keep an idea of what this equity section really is. It’s really all of this. So when we think about Indian equity, the equity at the end of the timing period, we’re gonna have to add the equity here plus the revenue minus the expenses will end up Normally, with a net credit, meaning the credits of all these accounts, all these equity accounts will typically when.
So when we consider this all as one lump sum number, we’re thinking about a credit balance account, which has debit components, including the debit component of expenses. So if we think about the types of debits then we know that we have things like cash, we’ve got things like land, we’ve got things like the Auto Supplies, we’ve got the phone with a computer, we’ve got building and equipment, these are things that we are owning, as of now, which we hoped to help generate revenue in the future, the goal being revenue generation, then we’ve got liabilities that’s going to be things like notes to the bank. It’s things like vendors accounts payable are typical couple liabilities, remember that the equity is what is owed to the owner, or in other words can be thought about as net assets meaning assets minus liabilities is equity. a sole proprietor of the owner’s equity partnership partnership equity, if it’s a corporation stockholders equity.
When we think about the equity section, then this is usually the most confusing piece whether it be a sole proprietor whether it be a partnership, whether it be a corporation because of that relationship, because notice here that we have the assets, liabilities and equity, we don’t see the income statement when considering the accounting equation in terms of debits and credits. Now if we were to add the breakout the equity section into its components, in particular, into the income statement components, then we would see the income statement components of the equity section that would include revenue which is a credit and expenses which are debit.
Now revenue, there’s typically only a one or two things we do remember like if we do computer service, all we do is computer service will have one revenue account expenses, we’re gonna have things like nothing, not the auto itself, but the gas and the maintenance on the expenses, we’ve got the wages expenses, we’ve got meals and entertainment expense, not the telephone or computer itself, but the use the telephone bill expense, those are going to be the type of expenses and note that revenue minus expenses means that we’re going to have credits minus debits or net income on the credit side. So when we think about the equity part of the income statement, the income statement is part of equity. We note that the credits should win, which makes sense because remember that equity itself as a credit balance account, so typically, we would think that the income statement, equation of net income would increase total equity.
And the way it would do that is it would take the credit balance of revenue minus the debit balance of expenses, meaning the credits will typically win on the income statement, resulting in total equity increasing, this will make more and more sense as we as we go through The accounting process and record journal entries and see the effect in terms of on net income in terms of equity. But just note that whenever the net income here goes up, that means that total equity is going up, whenever net income goes down, that means that the total equity is going down, we saw that in terms of the accounting equation, just keep that in mind same relationship will be there. When we think about debits and credits. Now we just need to add the fact that the net income is a net credit balance on the income statement meaning the credits of revenue or being the debits of expenses.
And therefore when revenue goes up or when net income goes up, it’s going to increase the credit balance of total equity. And when expenses go up, bringing net income down, then it’s going to decrease the net credit balance in total equity. So one more review of this account that would just need to memorize I would have this cheat sheet available. Before you, we will have the debits on the left credits on the right assets debit balance accounts, liabilities, credit balance accounts, equity credit balance accounts. That is the accounting equation. That is the balance sheet assets equal liabilities plus equity. We then have the income statement accounts of revenue, that’s a credit balance account and expenses. That’s a debit balance account. Those are the income statement accounts, revenue minus expenses, that is net income. And then remember that the entire equity section is the equity plus these temporary accounts of revenue and expenses. objectives we are now able to define debits and credits, list account normal balances and explain how debits and credits work.