Debits and Credits

What are debits and credits ?

Debits and Credits are the internationally accepted method and basis for recording business and financial transactions.

You do not need to know or understand these principles in order to keep basic business records for a small business. If you keep good and accurate records, you will be able to produce a simple Profit and Loss Account, which might be all that you need for your Self Assessment tax return.

If you trade as a Limited Company, it will be necessary to produce a Balance Sheet. In this case it is likely that you will need to understand debits and credits, or we would be pleased to prepare your Year End Accounts for you.

All accounting software uses these principles of Accounting and Bookkeeping - and does the debits and credits for you. There is one exception to this, and that is an accounting adjustment called a Journal.

Journals are often used to complete Year End Adjustments and you would have to know how to do the debits and credits, which is where the services of an accountant is advisable.

Double Entry Bookkeeping

The expression 'double entry bookkeeping' arises because there is at least one 'debit' and one 'credit' for every transaction. The benefit of this method of recording is that business records are always 'in balance', which is one principle of ensuring accuracy and control. This method, when done properly, ensures that a Balance Sheet can be automatically generated.

Accounting Transactions

All accounting transactions have at least 2 parts (or sides) (or 'legs'). These are the debits and credits, and there must be at least one debit and at least one credit in every transaction when it is recorded, for example a sale of your products.

The value of the debits and credits must balance numerically, ie. the the total value of the debits must equal the total value of the credits. Think of it like weighing scales, with debits on the left, credits on the right and it must balance. The total debits must equal the total credits.

Accounting Software deals with the debits and credits for you, so this section explains what is going on behind the scenes of accounting software.

If you do not use accounting software, for example you may use a simple spreadsheet, your accountant will put your records into debits and credits to create your Balance Sheet and Profit and Loss Account.

Good accounting software like QuickBooks will ensure that you stay in balance. For most transactions you won't see the debits and credits - the software will do this for you in the background. However, you will see debits and credits when you input a Journal (aka 'General Journal').

What is a Debit ?

A debit [DR] is one part of an accounting transaction, and is usually either an Asset (a balance in your favour) or a Cost (eg. Purchase or Expense).

What is a Credit ?

A credit [CR] is one part of an accounting transaction, and is usually either a Liability (something that you owe) or a Sale.

In Summary, every accounting transaction, for example a sales invoice, is a mixture of debits and credits, and at least one of each. The value of the debits must equal the value of the credits - ie. the debits and credits must balance in value for every transaction. Accounting software does this for you.

During the accounting process, each of the debits and credits end up in either the Balance Sheet or the Profit and Loss Account, and again, good accounting software eg. QuickBooks will do this for you if you are using it correctly.

Debit and Credit Examples

• The purchase of a pen for £2 for cash is a £2 debit to the Stationery Account and £2 credit to the Cash Account.

• A £50 BT telephone bill (to be paid later) is a £50 debit to the Telephone Account and a £50 credit to the BT Supplier Account. When the bill is paid, this is a £50 debit to the BT Supplier Account to clear it, and a £50 credit to the Bank Account.

• The purchase of some products for resale £500, purchased on credit, is a £500 debit to the Stock Account and £500 credit to the Supplier Account.

• When the products are paid for several days or weeks later, using online banking, that would be £500 debit to the supplier account and a £500 credit to the Bank Account. That means there is a £500 debit and a £500 credit on the Supplier account which match and need to be allocated to each other.

• When the products are sold it is a £500 debit to the Cost of Sales Account and £500 credit to the Stock Account.

• If the products are sold for £700 paid by BACS, it is a £700 debit to the Bank Account and £700 credit to the Sales Account.

Debits and Credits in Accounting Software

Accounting software is designed to help you get everything in the right place - using debits and credits.

Transactions in Sales Ledger (Accounts Receivable) and Purchase Ledger (Accounts Payable) will sort out the debits and credits for you.

Some transactions, particularly those which are only recorded in the General (or Nominal) Ledger require Journals - and you will need to know the correct debits and credits to record a journal properly. This will often need to be done by a trained accountant.

Some accounting software is more 'forgiving' than others. We recommend QuickBooks because a correction can be made very easily.