The subject of accounting can be a confusing one to those not familiar with debit, credit and other jargon used by accountants. It's relatively easy to understand once you have the right perspective and by simply following a few basic exercises, you can gain a better understanding.
Debit vs. Credit
In the typical double entry accounting method, every transaction has two entries. One entry is on the left, this is called the debit. The other is on the right, this is called the credit. To understand the way this is applied, you have to remember that a debit is associated with "what you got" and a credit with "where it came from." So a new business owner pays the $800 rent on his new office or store location. The first entry will be "what he's got" or, one month's rent, this would be the debit. The second entry will be "where is it from" or $800 removed from his checking account, this would be the credit.
The Balance Sheet
When all the debits and credits have been entered, the resulting report is called the balance sheet, because one side should have exactly the same amount on it as the other. On one side of the balance sheet are the assets, on the other, the liabilities and the owner's equity. The accounting equation is "assets = liabilities + owner's equity." A new business owner invests $20,000 in his business and opens a checking account. The first entry would be the debit, he's got $20,000 in his checking account. The second entry would be the credit, $20,000 came from his owner's equity. His assets now equal $20,000 and balance with his owner's equity at $20,000.
Profit and Loss
Each sale of a product or service carries with it expenses necessary to the sale. The profit and loss report compares the revenue generated to the expenses paid. If the end result is a positive number, the business owner has a profit. If not, it is a loss. If the business purchases items for resale, the cost of these items is known as the Cost of Goods Sold. COGS for short. A business owner purchases 20 items at $1 each to sell for $3 each. His COGS is $20. If he sells all 20 items for the full price, he will make $60. His profit is $40.
Putting it all Together
A new business owner invests $15,000 of his own money to open his new business and deposits the amount into his business checking. He borrows $100,000 to purchase a building to do business in. He buys $5,000 of inventory items at $5 each to sell at $15 each. 1st Entry - Debit to checking account of $15,000 2nd Entry - Credit to owner's qquity of $15,000
1st Entry - Debit to assets (he's got a building) $100,000 2nd Entry - Credit to liability (it came from a loan) $100,000
1st Entry - Debit to inventory (he's got inventory) $5,000 2nd Entry - Credit (from checking account) $5,000
COGS - $5,000 Profit - (if he sells all inventory) $15,000
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