Demystifying Your Accounts - Part 1 Debits and Credits

... back to syllabus

17 Sep 2013

Welcome to the Cloud Accounting Basics series. Written mainly for Cloud and Xero users, its also good for those who just want to have a better undertsanding of their accounts.

Isaac Newton (there’s a smart cookie) said “For every action there is an equal and opposite reaction. This is the third law of motion. The first law of accounting is

“For every debit there is an equal and opposite credit”

This is very important - and once you have grasped that money cannot be created or destroyed, only transferred, then your books will be a little bit easier to fathom.

The simplest way to illustrate this is in an everyday example:

On 1st September 2013, ABC Ltd invoiced XYZ Ltd, for £4,000. On 4th September 2013, ABC Ltd settled this account in full.

For the first part of the transaction (raising the invoice), you would CREDIT Sales (or Revenue) £4,000 and DEBIT Trade Debtors £4,000.

For the second part of the transaction (being paid), you would CREDIT Trade Debtors and DEBIT Bank Account.

The next stage may be to pay a couple of bills with this money. For example, a supplier invoice and a direct debit for the rent.

Firstly, the supplier invoice needs to be created: Let’s say 123 Ltd for £2,000 on 1st September 2013.

CREDIT Trade Creditors £2,000, DEBIT Purchases £2,000 

Then the payment:

CREDIT Bank account £2,000, DEBIT Trade Creditors £2,000

And the rent direct debit:

CREDIT Bank account £500, DEBIT Rent £500

See, every part of every transaction has a an equal and opposite credit and debit.

You will notice that a CASH  transaction (ie, a transaction in which the initiation and settlement occurs at the same time - in the above example the payment of the rent) is treated differently to a CREDIT transaction (ie, one in which there is a delay between the initiation and the payment). For the cash transaction there is only one transaction with a debit and a credit, whereas in a credit transaction there are two: the raising (or receiving) of the invoice, and its settlement.

So that’s the end of the first Demystifying. Keep an eye on the blog or @cloudacco for details of the next instalment which should be out around the end of September 2013.