In the accounting world, two types of transactions are made. Either an account is debited or an account is credited. This is often expressed in the form of a letter “T” with transactions on either side. A debit will appear on the left side like so:
500
A
credit, however, will appear on the right side. On any business transaction,
the total of the debits and the total credits must equal each other. There are
rules for what accounts are debited and what are credited and when this happens
and the rules are as so:
Ø When you increase an asset account, you debit it. When you decrease an asset, you credit it.
Ø When you increase a liability account, you credit it. When you decrease a liability account, you debit it.
Ø When you increase an owner’s equity account, you credit it. When you decrease an owner’s equity account, you debit it.
Confused? Don’t be. Actually it’s all logic. Your assets (what you own) are equal to the amount of your ownership in the business minus what you owe to others.
Look at it from a non-business perspective. What you own in your private life is equal to your cash and other possessions minus what you owe to others. If you paid them what you owe them, the amount you have left is actually what you own.
There is one aspect of owner’s equity that needs to be mentioned. There are two additional components of owner’s equity that create the final number of owner’s equity. These are your expenses and your income. The rule for these is as follows:
Ø To increase an expense account, you debit it.
Ø To increase an income account, you credit it.
You should be able to see how this works out. If increasing an owner’s equity account involves crediting it, then, naturally, it will involve increasing your income accounts since income increases your owner’s equity. If you want to decrease your owner’s equity, then, naturally you will want to increase your expenses by debiting them since debiting them decreases your owner’s equity.
Periodically your expenses and income will be closed into your owner’s equity accounts. What I mean by being closed into your equity account I mean the numbers will be transferred to the owner’s equity account. Your equity account will then increase as your income is transferred over and decrease as your expenses are transferred over. Hopefully, if you want to stay in business, the result will be an increase in your equity account.