If you want to learn accounting the concept of debits and credits is one of the most
important to understand. But, many struggle with it and for me it was the
same in the beginning because it's not something
that's completely explainable with logic. But, I managed to understand it and by the end of the video, so will you. (synthesizer music) In accounting, debits and
credits always go together. Every transaction will
have debits and credits and at least two accounts
will be affected. So remember, one transaction
affects two accounts. If one account is debited, then the other one must be credited. Just think of it like a bank transfer. When you send someone money, it comes out of your bank account and it goes into their account. In accounting, instead
of these piggy banks we use T accounts. Every account has it's own T. The left side of the T
is where the debits go. Credits go on the right side. That's already the first main
rule you have to remember. Debit and credit do
not mean plus or minus. It literally just means debit goes to the left side of a T account and credit goes to the
right side of a T account. Debit means left, credit means right. That's rule number one. The second important rule is that for every transaction, the total amount of debits must equal the total amount of credits. If you debit an account for 100, you must credit another one with 100. There can be more than two accounts involved in a transaction, but never less than two. That's rule number two. Now, the third rule usually
creates a lot of confusion, but you'll be fine because I
have a secret weapon for you. More on that later. Before we dive right in, let's do something else first that we'll need in the process, and that's to figure out
the balance in a T account. The balance is basically
the total of an account. So, let's say we have these
two accounts visualized at T's. Then, we record some transaction to them. First, account number
one gets a debit of 500, and account number two
gets a credit of 500. For the second transaction,
account number two gets a debit of 100 and account number one gets a credit of 100. With that, we successfully
applied the first two rules of debit and credit. We put debits on the left
side of the accounts, credits on the right side. And, for each transaction
the total of debit and credit was the same, so far so good. Now to calculate the balance
or total for the accounts, we add up the amounts on
the debit and credit side for each account separately. Account number one has
500 on the debit side and 100 on the credit side. We deduct the smaller sum of credits from the bigger total of debits which gives us 400. In accounting, we call this
a debit balance of 400. For account number two, it's the opposite. It has a credit total of 500
and total debits are 100. Again, we deduct the smaller
one from the bigger one, account number two has
a credit balance of 400. Here comes the confusing part. Let's say we have another transaction that adds another debit of
50 to account number one and one more transaction
with a debit of 100 going to account number two. Let's just say the credits
for these transactions go to different accounts. We don't need to worry
about these for now. What would happen is that the balance of account number one would increase while the total of account
number two decreases. Both received a debit,
but one account increases while the other one decreases. They are behaving differently. And, that's rule number three. It depends on the account
if a debit or a credit increases the balance
or if it decreases it. And, that's really the secret to understanding debit and credit. Like we saw in our example, the balance of account number
one increases with the debit while the balance of account
number two decreases. You may ask, well how do
you know which one it is? Fortunately, there are only
two groups to remember. The first group includes assets, that's the resources the
company owns and uses, like buildings, machines,
equipment and so on. Dividends, that's when
the company distributes it's profit and cash to the owners. And expenses, that's money
we pay for goods or services the business purchased. All accounts in this group are debits, which means that their balance
will usually be a debit. Therefore, the total of these accounts will increase when they get another debit and will decrease with
they get another credit. So, account number one
in our previous example would be in this group. The second group includes liabilities, which is money we still owe to others, like to the bank, to
suppliers or to the IRS. Owner's equity, that's the
money the owners of the company put into the business. And revenue, that's the money we receive for sales to our customers. All accounts in this group are credits which means that their balance
will usually be a credit. Therefore the total of
these accounts will increase when they get another credit and will decrease when
they get another debit. So, account number two
in our previous example would be in this group. And, that's rule number three. It's really important
that you memorize this because to record any transaction, you have to answer two questions. Which accounts are affected?
Did accounts go up or down? We will cover this in more
detail in the next video, but just so you know that in order to answer
question number two, you need to understand if an account is a debit or a credit account. If you have trouble remembering this, just think of ADEx LER, Accountants don't expect
low earning rates. Assets, dividends, expenses, liabilities, equity, and revenue. ADEx are debits. The balance of these accounts
increases with debits and decreases with credits. So, let's take cash for
example. Cash is an asset. So, it resides on the
debit side of our equation. When you take money out of your
account to pay for something you reduce your cash balance. And, remember our rule, the
balance on the debit side increases with debit and
decreases with credit. So, do we debit or
credit the case account? We credit it because we reduce it. LER are credits. The balance of these accounts
increases with credits and decreases with debits. Take a loan, for example,
which is a liability. When you take out a higher loan, you credit the loan account. When you pay back a loan, what do you do? You debit the loan account, which will reduce it's balance. So, that's really all there is to it. All you have to remember is accountants don't
expect low earning rates. ADEx LER. Assets, dividends, expenses, liabilities, equity and revenue. This will help you determine
debit and credit accounts. Just practice it and it's eventually going to become second nature to you. In the end, you're not
even going to have to think about it anymore. Wait a minute. How does my debit card
fit into this definition? One more thing regarding
debits and credits. I just want to clear this up because it creates confusion
for a lot of people. The reason for the confusion are banks and how we talk to them. For instance, when you
put money in your account the bank will credit it. When you take money out of your account, they will debit it. A debit card is issued for the purpose of accessing your funds
and to take money out from your account. Now, if you think about this, it really seems like
it's exactly the opposite from what we just learned. Cash is an asset. And, according to ADEx LER,
resides on the debit side of the account equation. And, therefore, increases with a debit. If you're adding money, you will debit it, and if you're taking money
out, it will be credited. So, why is this backwards with banks? Do the general rules of
accounting not apply to them? Actually, they do, but they look at it
from their point of view not yours. Think about that. When you put money in
your checking account, it belongs to you, not to the bank. The bank just holds it for you. So, for the bank, this
money really is a liability, because at some point, they're going to have
to pay it back to you. According to ADEx LER,
liabilities are on the credit side of the equation, right? And, to increase a liability,
you will have to credit it. Therefore, the bank
will credit your account when you put money in it. Likewise, when you buy
stuff with your debit card, this will reduce the
balance in your account. The bank owes you less money. Therefore, it will be debited and hence the name, debit card. So, this is why it seems backwards. The same accounting rules
apply to banks as well as to any other business in the world. The terminology they use may be confusing because it's from the
point of view of the bank and not from your point of view. So, you might ask, what
about credit cards? Well, if you're issued a credit card, the bank or the provider of the card, is providing a line of credit to you. In other words, credit cards
combine payment services with the extension of credit. And, like for any loan, you're
going to be charged interest, actually very high interest, for the balance you carry
over from month to month. In addition, credit cards may offer additional insurance on purchases or make it easier to request
a refund or a return. But, in the end, it's main purpose is to award you a line of
credit or credit limit, hence the name. I hope this was helpful
to avoid confusion. Please just stick to the definitions of debits and credits that we just learned and always remember ADEx LER and you're going to be fine. If you enjoyed this video,
give it a thumbs up. And, if you want to improve your skills, consider subscribing. And, don't forget to hit that bell so you don't miss out when
I put out new videos here. Thank you for watching. See you in the next video. (upbeat music)
