What's it all mean?

Okay, we've debited and we've credited, but what does it all mean?

Let's look at each in turn.

What are debits?

A debit is either an expense or an asset.

In the basis of book keeping, we learnt that debits are the receiving aspect. A debit will therefore be the representation of a value received.

So if you bought a car, the value of the car would be represented by a debit entry in the Motor Vehicle account, and it is an asset.

If you paid for utilities, the value of the services rendered by the utility company is represented by a debit entry in the Utility account, which is an expense.

What's the diff?

The difference is in the lifetime value.

A car's value is over several years, whereas the value of services rendered by a utility company is month to month. A car is an asset whose value to the business extends beyond one year. So, although buying a car is an expense, it is categorized as an asset because it's value to the business extends beyond a year.

When you make calls on your telephone in September, the value of those calls have been expended in that month and does not carry through to October. The benefit of services rendered by utility companies is only for that particular month. It is therefore an expense.

What are credits?

A credit can be interpreted as capital, liability or an income.

Capital is the amount of money put into the business by the owner of the business. In book keeping, we regard the owner as an entity separate from the business. With that in mind, whatever the owner puts in is considered as owing by the business to the owner.

A liability is a debt owed to another business or person. So if you buy a car on hire purchase, you create an asset by acquiring the car and you also create a liability in the amount you owe to the hire purchase company. The entry would be to debit the motor vehicle account and credit the hire purchase company account.

Income on the other hand represents revenue earned. A service or product is the giving aspect and the income gained from that is the receiving aspect. An income is, like with expenses, earned in that particular month only.

Summing up
Okay, so step 1 was to understand the basis of accounting, which is debit and credit. Step 2 was to understand what a debit and credit represented.

In a future post, we will get into a bit more detail and look at the long and short term interpretations of it.