ABC of Accounting – Understanding Debits and Credits

Every business transaction consists of at least two entries, one debit and one credit, this process is termed as double entry bookkeeping as every entry must balance. An entry can involve more than one debit as it may relate to various charges but the credit must equal the debits and visa versa. In bookkeeping debit entries always appear on the left and credit entries on the right.

Understanding the principles

Understanding which accounts you should debit and which ones you should credit can be a challenge, so we hope to explain the principle and clarify the reasoning behind this. Every transaction must have an equal and opposite side, for a charge to go to one account it has to come out of another.

For example, when your company sells either a product or a service a customer invoice is created, this contains the net amount £1,000.00 (the amount before vat) the vat element £200.00 and the total £1,200.00. When this invoice is entered into your accounting system three entries are created, a credit to your sales account with the net amount, a credit to your vat account with the vat amount and a debit to your Debtors account for the total.

The total amount within the Debtors account will remain there until the invoice is paid. Once paid and the funds appear in your bank account you can create the payment entry which would be a credit to the Debtors account clearing the invoice and a debit to your bank account as funds received.

One area that does cause confusion is when your bank say they will credit your account, and from their perspective that’s exactly what they are doing, and debting your account means that funds are coming out of it, because to your bank you are a creditor. The bank hold your funds as their assets and in turn show you and all other account holders as creditors, which they show as liabilities, monies they are holding for as and when you wish to withdraw funds from your account.