| Alright," Said Steve's new friend. "Let's answer 'what | | | | is self-balancing. |
| are debits and credits' question." | | | | "Okay," said Steve. "So every time my business has a |
| Debit comes from a Latin word which means "that | | | | transaction I need to record it as both a debit and a |
| which is owing". Credit also comes from Latin meaning | | | | credit." |
| "to trust or believe". In the past, around the 15th century | | | | "That is correct," His friend said. "There is always at |
| or so, you would keep a record showing who you | | | | least one debit and on credit to the accounts that are |
| owed money to and who owed you money. | | | | effected by the transaction." |
| People would write down who they owed money to | | | | Steve's reaction, of course, was "huh'? |
| on the left side of the page and naturally, the right side | | | | Accounts are records of resources, claims to |
| of the page was used to record money that you | | | | resources, or other events that keep track of any |
| were to receive. | | | | changes. |
| It was this convention that evolved into our modern | | | | Basically, you can think of accounts as buckets. You |
| system of accounting. | | | | can fill them up and you can take stuff out. |
| Today, we record the money we pay to others, as | | | | Take cash for example. As you receive cash you |
| debits, on the right. Likewise, any money that we get is | | | | throw money into the bucket. When you spent cash |
| recorded, as a credit, on the right. | | | | you have to reach in and take money out. You can |
| But we have also taken the system further. We have | | | | always know how much is in the bucket simply by |
| created an accounting rule that says: For every | | | | counting what is inside. |
| transaction, the value of the debits must equal the | | | | Every transaction results in things moving from one |
| value of the credits. | | | | bucket and moved to another, into buckets, or out of |
| It is the use of these debits and credits that give the | | | | buckets. You might have one account for cash, one |
| double entry system is ability to record both sides of a | | | | for your vehicle, or one for your house. Your cell |
| transaction. | | | | phone bill might be another. Businesses have buckets, |
| Here is your first question. Let's say you paid your cell | | | | accounts, for everything. |
| phone bill, would that be recorded as a debit or a | | | | In the cash of your cell phone bill, when you pay it, you |
| credit? | | | | are taking the money out of one bucket, your cash |
| It would be a debit. Why? Because debits are used to | | | | bucket, and placing it in your cell phone expense |
| record the money we pay to others. But, that is only | | | | bucket. |
| half of the answer. | | | | If you buy a house, you are taking money out of your |
| Remember, what we just said about the accounting | | | | cash bucket and putting a house into your 'home' |
| rule; debits equal credits, for every transaction. That | | | | bucket. Of course people don't unusually buy a home |
| means that there is another side. | | | | with cash. Instead, along with putting a house into your |
| Since we already have a debit, we need a credit. In | | | | 'home' bucket you would place an IOU into your |
| this case, we paid cash for the bill, so cash gets | | | | 'Mortgage' bucket. Then every time you make a |
| credited. | | | | payment, you take money out of your cash bucket |
| We now have a complete transaction. Cash gets | | | | and you would take that same amount out of the IOU |
| exchanged for a cell phone bill. | | | | in your 'Mortgage' account. |
| While this might at first seem odd, it is the use of | | | | "That seems easy enough," said Steve. "But how do I |
| debits and credits gives the double entry system built-in | | | | know which buckets to use for each transaction?" |
| checks and balances. This is because the total of the | | | | "Before I can answer that," said his friend. "We will |
| debit values recorded must equal the total of the credit | | | | need to talk about the categories that accounts fall |
| values recorded. Unlike the single entry system of | | | | into. That will be what we discuss tomorrow over |
| accounting, which does not use debits and credits, | | | | lunch. |
| errors are evident right way. This double-entry system | | | | |