ACCOUNTING BASICS: Debits and Credits Explained

In this video I'm going to explain to you what Debits and Credits aren't, define them, and show you why this. . .

is going to help you out. [Music] Hey guys, my name's James and welcome back to another episode of Accounting Stuff! This video is the second in a series that I'm creating on Accounting Basics.

If you missed the first, check out the link that I am putting in the description below. This video is going to be all about the differences between Debits and Credits. Make sure you stick around to the end because I've got a tip that I think is gonna help you loads!

Exciting stuff, are you ready? Let's do this! To properly understand Debits and Credits I think it's important to make a couple of points clear so we can remove any misconceptions.

Debits and Credits are neither good, nor bad. Debits and Credits are not the same as adding or subtracting. Debits and Credits are words used to reflect the duality or double-sided nature of all Financial Transactions.

If you need an analogy to help you visualize this. . .

then you can think of Debits and Credits as Heads and Tails on a coin, since there are equal and opposite sides to every transaction. In the world of finance money doesn't magically appear or disappear. For money to go to one account it has to come out from another.

Accountants consider every transaction to involve a flow of "Economic Benefit" from a source to a destination. Urgh. .

what is Economic Benefit? Economic Benefit is the potential for an asset to contribute either directly or indirectly to the flow of an entity's cash. I was saying that accountants consider every transaction to involve a flow of Economic Benefit from a source to a destination.

Well, Credits represent the source, and Debits represent the destination. Destinations that Economic Benefit can flow to include Assets like Cash, Buildings and Amounts Owed to you by others, but also Expenses where business pays a third party for a good or service they have provided, and Dividends where a business distributes some of its cash to its owners. On the other hand, sources that Economic Benefit can flow from include Owner's Equity, where a businesses owners give their cash to the business, Liabilities such as Amounts Owed to a bank in exchange for a loan, or to suppliers for providing a good or service, and Revenue.

So let's bring back up that Accounting Equation that we discussed in the previous video, and I'll prove this to you. Assets equal Liabilities plus Equity. Now we know that Assets are represented by Debits and Liabilities by Credits, however Equity is a tricky one.

To understand it properly we have to expand it into the components that make it up. Now for disclosure here. .

. we're about to do some maths. Don't be afraid, we're just going to do some simple rearrangement here.

If maths isn't your thing, maybe watch this next section through a couple of times so you can wrap your head around it. You'll be okay. Equity equals Owner's Equity paid in less Dividends paid out plus Retained Earnings.

I said in the previous video that we can think of Retained Earnings as Profit Held for Future Use. Well, Profit is made up of Revenue less Expenses. So let's replace Retained Earnings in our Accounting Equation with Revenue less Expenses.

We have. . .

Equity equals Owner's Equity paid in less Dividends plus Revenue less Expenses, and now let's take this definition of Equity and break it out in our Accounting Equation. Assets equal Liabilities plus Owner's Equity paid in less Dividends plus Revenue less Expenses. And finally let's do a little rearrangement so we have.

. . Dividends plus Expenses plus Assets equal Liabilities plus Owner's Equity paid in plus Revenue.

The left-hand side represents Debits these increase when Debited and decrease when Credited. The right-hand side is the opposite, these are Credits. These increase when Credited and decrease when Debited.

Now I mentioned at the start of the video that I have a tip for you to remember all this. "This is going to help you out". Well, here it is.

. . "DEALER".

. . D E A L E R.

. . "DEALER".

If you are ever in doubt which side of the Accounting Equation these terms sit on then you only have to remember this one word. "DEALER". Right, I think we covered a lot there so let's recap some of those main points.

Debits and Credits are words used to reflect the duality or double-sided nature of all Financial Transactions. Debits represent the flow of Economic Benefit to the destination. Credits represent the flow of Economic Benefit from the source.

Debits include Dividends, Expenses and Assets. Credits include Liabilities, Owner's Equity paid in, and Revenue. This is reflected through the Accounting Equation which can be expanded and rearranged to show as.

. . Dividends plus Expenses plus Assets are equal to Liabilities plus Owner's Equity paid in plus Revenue.

An easy way to remember this is "DEALER" thank you for watching today's video, if you found it useful give it a like. If you're interested in watching more don't forget to hit that subscribe button, that's all for today see you next time!