Accounting basics

Debits and credits. These, and the five parts of the Chart of Accounts are the core of the accounting process. Here is how they operate. To go back to high school algebra, remember what Mr. Math Geek said so often you got tired of it: "What you do to one side of an equation you must do to the other." Here is what he is getting at. If you're not a numbers person, think this one through so you understand it.

If you have a simple equation of 2+3 = 4+1, you know both sides equal 5. Naturally, if you add 3 to the first side and not the second, you're saying 8=5. This isn't true. So, to make this a true statement, you also have to add 3 to the second side. 8=8. True statement! Mr. Geek would be proud. If both numbers effect the same side of the equation, the net of the two must equal zero. Using the same example: 2+3= 4+7-3-4+1. Combine your figures on each side of the = and you still have a true statement: 5=5. Now to accounting....

The accounting equation works off the same idea, using the five parts of the Chart of Accounts. It's set up like this:
Assets = Liabilities + Equity + Revenue + Expenses
To complicate things, Mr. Pacioli, the father of accounting, said we have to use debits and credits to make this work. What throws people off is that is some instances a debit increases an account and in other instances a debit decreases an account. In the diagram below, a + means an increase and a - means a decrease. Take a look!

The equation: Assets = Liabilities + Equities + Revenue-Expenses
Debits increase assets and expenses and they decrease liabilities, equities and revenue.
Credits to the exact opposite. The decrease assets and expenses and they increase liabilities and expenses.

This is the foundation for that familiar term "Double Entry Accounting. Every transaction has both sides - debit and credit - or your equation won't remain true. Here is an some example.

** You took $50 cash from the business out of your pocket and put gas into your car. This is an increase to your expenses and a decrease to your cash. The result: Debit expenses (increase) and Credit cash (decrease, since it's an asset). You have both sides of the entry and you effected both sides of the accounting equation with the same amount, keeping it in balance and keeping it a true statement. Often, if you can identify what one half of the entry, you can figure out the other half. Another example is buying something on account (charging it so you can pay for it later). You need copier paper, so your local supply store says "I'll send you a bill you can pay in 30 days." This purchase goes on your books as a debit (increase) to the expense (office supplies) and a credit (increase) to accounts payable. Later, you send the payment and credit (decrease) accounts payable) and credit (decrease) cash.

More to come later. Time to go to bed.