Basic Concepts and Terms of Accounting

Setting up your accountant system is not hard. There are only a few basic concepts and terms for you to understand. Knowing these will clear up any confusion you may have had when talking with your CPA or Accountant. We like to use technical terms not to confuse people but it just how we talk. IT people do the same thing.

Debits and Credits
They are the foundation of the accounting system. Understanding how debits and credits work will give you the understanding of how the whole system works. Every entry made in an accounting system has two parts, the Debit and the Credit. The total of the debits must equal the total of all the credits. If they don't, the entry is out of balance. That's not good. Out-of-balance entries throw your balance sheet out of balance.

The accounting programs are programmed not to allow an out of balance entries to be made. They will just beep or a message will pop up tell you it is out of balance until you fix your error.

Depending on what type of account you are dealing with, a debit or credit will either increase or decrease the account balance. Figure 1 illustrates the entries that increase or decrease each type of account.

Figure 1 - Debits and Credits vs. Account Types

Account          Type Debit           Credit
Assets              Increases              Decreases
Liabilities         Decreases            Increases
Income             Decreases            Increases
Expenses         Increases              Decreases

Notice that for every increase in one account, there is an opposite (and equal) decrease in another. That's what keeps the entry in balance. Also notice that debits always go on the right and credits on the left. This is the hardest part of accounting for most beginners.

Let's take a look at two sample entries and try out these debits and credits:

In the first stage of the example we'll record a Telephone expense of the company:
Telephone                        $1,000
Accounts Payable                         $1,000

If you looked at the general ledger right now, you would see that Payable had a balance of $1,000 and the telephone expense also had a balance of $1,000.

Now we'll record the payment of the Phone Bill.:
Accounts Payable          $1,000                 
Cash                                                 $1,000

Notice how both parts of each entry balance? See how in the end, the payable balance is back to zero? That's as it should be once the balance is paid. The net result is the same as if we conducted the whole transaction in cash:
Telephone                       $1,000
Cash                                                  $1,000

Of course, there would probably be a period of time between the recording of the receivable and its collection.

That's it. Accounting doesn't really get much harder. Everything else is just a variation on the same theme. Understanding the debits and credits and how they increase and decrease each type of account is the first step and the most important step in understand and mastering accounting.