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Showing posts with label bookkeeping basics. Show all posts
Showing posts with label bookkeeping basics. Show all posts
Friday, August 28, 2009
Friday, August 21, 2009
What is Double Entry Bookkeeping
I have had a great response to my site and people are getting benefits from the free e-course on how to set up your bookkeeping business. I am also please to be getting questions in my email about some bookkeeping basics from people who are new to bookkeeping.
To help them out, here is a very basic analagy about P&Ls and balance sheets, debits and credits without getting too complex.
What is Double Entry Bookkeeping?
For every action there is an opposite reaction. The same can be said for double entry bookkeeping. For every debit there must be a credit. In bookkeeping, you can not have a one sided entry, that is, if you have a debit somewhere, a corresponding credit for that transaction must also exist.
If you think about a chart of accounts as a filing system, this is the easiest way of understanding what a chart of accounts is and what you will do to it with the debits and credits.
Think of two filing cabinets, one is called profit and loss and the other one is called balance sheet. Inside each filing cabinet are lots of folders with different labels like income, expenses in the profit and loss cabinet and assets and liabilities in the balance sheet cabinet.
If you have a debit there must be a corresponding credit, so lets say you have a telephone bill for your business and it is $100 and you have just paid for it. You would file the telephone bill in the profit and loss cabinet in the telephone section. There is your debit. Since you know double entry bookkeeping means there must be a matching credit somewhere, the credit will be filed in the balance sheet cabinet in your bank account folder.
As you can see there was a debit (in the telephone expenses) and a corresponding credit in the bank account Double entry bookkeeping is really that simple, a debit must have a credit. The most challenging thing is to know when to use a credit in an account or a debit.
Going back to our filing system analogy, the balance sheet and the profit and loss have special rules. Depending on the type of account will depend on if you use a debit or credit. Sometimes people get very confused about this, but it is quite simple.
An income account is a credit, so if you increase your income account, you use a credit. If you decrease it you use a debit. The expense account is therefore opposite to this. The expense accounts are debit accounts, so if you increase your expenses, you debit the account, if you decrease them you use a credit.
Looking at the balance sheet we can see the similar patter. An asset account, such as your bank account is a debit account, which means to increase your bank account, you debit the account. To decrease the account, you credit it.
Liabilities on the balance sheet are kept in a credit account, so if you increase your liabilities you credit the account, decrease the account you debit it.
Of course this has been explained as simply as possible, but if you remember the basic rules, it is quite easy to grasp double entry bookkeeping.
To help them out, here is a very basic analagy about P&Ls and balance sheets, debits and credits without getting too complex.
What is Double Entry Bookkeeping?
For every action there is an opposite reaction. The same can be said for double entry bookkeeping. For every debit there must be a credit. In bookkeeping, you can not have a one sided entry, that is, if you have a debit somewhere, a corresponding credit for that transaction must also exist.
If you think about a chart of accounts as a filing system, this is the easiest way of understanding what a chart of accounts is and what you will do to it with the debits and credits.
Think of two filing cabinets, one is called profit and loss and the other one is called balance sheet. Inside each filing cabinet are lots of folders with different labels like income, expenses in the profit and loss cabinet and assets and liabilities in the balance sheet cabinet.
If you have a debit there must be a corresponding credit, so lets say you have a telephone bill for your business and it is $100 and you have just paid for it. You would file the telephone bill in the profit and loss cabinet in the telephone section. There is your debit. Since you know double entry bookkeeping means there must be a matching credit somewhere, the credit will be filed in the balance sheet cabinet in your bank account folder.
As you can see there was a debit (in the telephone expenses) and a corresponding credit in the bank account Double entry bookkeeping is really that simple, a debit must have a credit. The most challenging thing is to know when to use a credit in an account or a debit.
Going back to our filing system analogy, the balance sheet and the profit and loss have special rules. Depending on the type of account will depend on if you use a debit or credit. Sometimes people get very confused about this, but it is quite simple.
An income account is a credit, so if you increase your income account, you use a credit. If you decrease it you use a debit. The expense account is therefore opposite to this. The expense accounts are debit accounts, so if you increase your expenses, you debit the account, if you decrease them you use a credit.
Looking at the balance sheet we can see the similar patter. An asset account, such as your bank account is a debit account, which means to increase your bank account, you debit the account. To decrease the account, you credit it.
Liabilities on the balance sheet are kept in a credit account, so if you increase your liabilities you credit the account, decrease the account you debit it.
Of course this has been explained as simply as possible, but if you remember the basic rules, it is quite easy to grasp double entry bookkeeping.
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