From the first use of handwritten ledgers to cloud-based accounting tools used today, debits and credits are the heart of accounting. But what are they, and how do these relate to overall financial management? Let’s demystify accounting debits and credits.
The Confusing Terminology of Debits and Credits
The terms debits and credits have a double meaning. Accounting debits and credits are distinct from those relating to your bank account. One thing that makes accounting hard is the language itself! This is because accounting terminology is filled with synonyms and overloaded terms.
For example, the term customer sale can have multiple synonyms. Sale invoice, customer invoice, billing, and account receivable all still describe what a customer purchased – a customer sale. And the word “credit” closely resembles the term “credit memo”—which adds further confusion about its use in accounting.
Despite this, we can break down the confusion by looking at how banking and accounting define and manage debits and credits separately.
*Understanding accounting terms is half the battle of financial management. Check out Accounting Seed’s Accounting Vocabulary Guide, for an easy breakdown of these terms and more. You’ll see comprehensive textbook definitions alongside ‘street’ definitions. We promise you’ll have fun learning these accounting definitions!
Accounting Debits and Credits
In accounting, debits and credits are balanced entries in a double-entry accounting system.
- A debit is an event that increases an expense account or asset. A debit is also a decrease in a liability or equity account. In an accounting entry, debits are always marked on the left.
- A credit represents an entry that either increases an equity account or liability. A credit can also decrease an expense account or an asset. Credits are right entered on the right of an accounting entry.
In a double-entry accounting system, your debit entries must always equal your credit entries. Also, every entry you make into a general ledger system will generate at least one debit amount and one credit amount. Furthermore, a debit to an asset account will increase its value, while a credit to an asset account (like cash) will decrease its value.
Banking Debits and Credits
Banking debits and credits are transactions that affect your bank account. The use and language here are totally opposite of accounting debit and credits. A debit entry to your bank account will decrease its value while a credit will increase its value. To eliminate confusion, several banks have moved away from these terms by using more logical ones like receipts, deposits, disbursements, or fees. Here are a few examples:
Customer Credit Memo
This type of memo is used to forgive payment that is due to you from a customer.
Vendor Credit Memo
Conversely, a vendor credit memo is used to forgive payment that is due to a supplier.
Credit (Lending)
In the lending arena, credit denotes a set amount of money you are willing to loan and have a customer owe you for goods or services rendered.
Use Debits and Credits Software
No matter your industry or the size of your business, managing the debits and credits you generate is critical. While it can be confusing to recognize and account for these different transactions, dedicated debits and credits software can do this for you. Systems like Accounting Seed focus on accounting automation to give you more accurate, streamlined financial management.
Our flexible general ledger is optimized to help you understand the transactions generated by your operation. We provide ultra-flexible financial reporting with drag-and-drop configurations and built-in graphics. This allows our users to dive deeper into their company’s data to make the best strategic decisions. Sign up for a free, custom demo today by calling us at (410) 995-8406.