Debit & Credit: It's All About Trust
An interesting way to understand Debit and Credit is by looking at their origin in latin: Debit is from Debitum which can be loosely translated to “entrusted amount” while Credit is Creditum or, for a lack of a better term, “giver of trust”.
Remember, if trust is debited to you,
give credit to where credit is due!
Now, imagine you are the accountant of an enterprise that buys and sells bananas. Try Ben Affleck or Anna Kendrick from The Accountant (2016 film).
The business owner entrusted you with $100 as initial capital. You grabbed a pen and paper to record:
| Entry (1) | ||
|---|---|---|
| Debit | Cash | $100 |
| Credit | Owner’s Capital | $100 |
This translates to: I have been entrusted with $100 cash by the owner.
Congratulations, you have just made your very first accounting entry!
Let’s suppose, the owner wanted to sell more bananas but didn’t have the money to add more capital. He went to a neighbor and borrowed $50. Here’s a record of the additional $50 cash entrusted to you:
| Entry (2) | ||
|---|---|---|
| Debit | Cash | $50 |
| Credit | Loan Payable | $50 |
Here’s a tally of both transactions:
| Assets | Liabilities & Capital |
|---|---|
| Cash $150 | Loan Payable $50 |
| Owner’s Capital $100 | |
| Total $150 | Total $150 |
Now, two parties have entrusted you with their money: $100 from the owner and $50 from the neighbor for a total of $150 cash.
Later in the afternoon, you went shopping with the owner in a nearby public market bringing along the $150 cash. You paid a vendor $130 in exchange for bananas. How would you record this transaction?
Our initial idea of Debit and Credit seems not appropriate in this case since there is no change to the $150 amount entrusted to you. You are simply exchanging $130 cash to $130 worth of bananas. To record this transaction you book:
| Entry (3) | ||
|---|---|---|
| Debit | Bananas | $130 |
| Credit | Cash | $130 |
This means that Debit is also used to record an item you received and Credit for an item you have given up in exchange. In effect, sometimes Credit is used to reduce a Debit balance!
Here’s a new tally after exchanging $130 cash to $130 worth of bananas:
| Assets | Liabilities & Capital |
|---|---|
| Cash $20 | Loan Payable $50 |
| Bananas $130 | Owner’s Capital $100 |
| Total $150 | Total $150 |
$130 cash in the debit side has been converted to bananas. No change in the credit side.
You spent another hour walking around the public market looking for more bananas to no avail. So the owner decided that you drop by the neighbor’s house to return some of the borrowed money with the spare $20 cash. How would you record this?
You reduce $20 in the amount entrusted by the neighbor so it will be:
| Entry (4) | ||
|---|---|---|
| Debit | Loan Payable | $20 |
| Credit | Cash | $20 |
You may be wondering why we didn’t Debit cash by negative $20 and Credit Loan Payable by negative $20. This after all is just a reduction to Entry (2), right? Well, you are not allowed to use negative numbers in accounting entries. To reduce a balance, you need to use Credit for a Debit and Debit for a Credit similar to Entry (3).
Here’s the final tally:
| Assets | Liabilities & Capital |
|---|---|
| Bananas $130 | Loan Payable $30 |
| Owner’s Capital $100 | |
| Total $130 | Total $130 |
The day ended with $130 worth of bananas entrusted to you by the owner for $100 and by the neighbor for $30. Don’t betray that trust by eating the bananas!