In order to effectively track finances, small business should undertake an accounting system or better yet, go to a specialised accounting firm. One of the most important tools in accounting systems is the use of credits and debits. Accountants use these in journal entries to change the amount of money in an account.
The type of account is the primary factor that determines the difference between credits and debits. It’s also vital to keep in mind that for every journal entry, the amount debited will equal the amount credited.
Debits usually increase asset amount. A credit will decrease an asset amount. So for example, if your accountant debits “cash” for fifty thousand pound and credits “accounts receivable” by fifty thousand pound, there is a fifty thousand pound increase in cash and the same amount decreases in accounts receivable.
Debits reduce liabilities, credits increase them. So for example, if your accountant debits “accounts payable” by ten thousand pounds and credits “cash” by ten thousand pounds, the accounts payable is decreased by this amount because the company is paying it in cash to reduce it.
If the journal entry was debit “purchases” by ten thousand pounds and credit accounts payable by this amount then the accounts payable increases to ten thousands pounds over the cost of the purchases.
Income accounts can include revenues, gains, expenses and losses. If an accountant debits an income account, they’re increasing an expense or loss.
If the account is credited, they’re increasing revenue or gains. So this means that if a company sells equipment for cash at a loss, the accountant would debit “Loss on Equipment” and “Cash” then credit “Equipment”. Debiting “Loss on Equipment” is acknowledging a loss. Debiting cash shows an increase in cash because the company receive it. Crediting equipment shows a decrease because the equipment is sold.
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