What are Debits & Credits?

Debits & credits show a flow of money or value from one account to another.

How They Work

Suppose you were keeping the accounting records for a retail store that had just opened.

The Double Entry Accounting System

To overcome this problem, businesses use the double-entry accounting system.

Instead, it was designed with checking in mind.

Accounts

Making all this possible is a system of accounts.

How Debits & Credits Work With Cash Transactions

Cash transactions are those transactions the business makes with the bank.

They include cash receipts, which are shown as deposits on the bank statement. 

And they include cash payments, which are shown as withdrawals on the bank statement. 

With the double-entry system, you need to record every transaction made with the bank.

For example, to start up, the owner may have put some of their own money into the business.

They would deposit this money in the business’s bank account.

To record this transaction, you credit the capital account.

This shows that the money came from the owner’s capital.

At the same time, you debit the cash account.

This shows the money was deposited in the bank.

The business owner may also borrow some money from a friend or a relative.

They will deposit this money in the bank, as well.

To record this transaction, you credit the loan account.

This shows money came from a loan.

Then you debit the cash account.

This shows the money was deposited in the bank.

After this, the business owner may rent premises for the store.

Here, they would take money from the checking account.

Then they send this money to the landlord.

To record this transaction, you credit the cash  account.

This shows money came from the bank.

Then you debit the rent account.

This shows the money was used for rent.

After this, the business owner may buy goods to sell in the store.

Again, they take money from the bank.

And they use this money for purchases.

To record the purchase, you credit the cash  account.

This shows money came from the bank.

Then you debit the purchases account.

This shows the money was used for purchases.

The store will then sell these goods.

If cash sales, the business will deposit the takings in the bank.

To record the transaction, you credit the sales account.

This shows the money came from sales.

Then you debit the cash account.

This shows the takings were deposited in the bank.

By month end, you should have a complete record of cash transactions.

You will have one record of them in the general accounts.

And because you use a double entry, you will have a duplicate record of those transactions in the cash account.

As such,  the cash account  should contain the same transactions as shown in the other accounts.

So for your record of transactions to be correct, they should be the same as those shown in the cash account

This is why the checking account is known as a control account.

All you need check is the control account.

If correct,  because of the double-entry, all the other accounts should be correct, as well.

To check your record of cash transactions, you compare your checking account to the month end bank statement.

If the records agree, it shows the control account is correct.

© R.J (Bob) Hickman 2020

This topic strip explained how the cash account fits into the system.

The creditors control account works along much the same lines.

So does the debtors control account, except it is checked differently.

If you want a complete understanding of control accounts, you can easily do so within the 7-day free trial period.

While you’re at it, you may like to look at things like the trial balance, period-end adjustments, balance sheet, reversing adjustments, and any of the 200 accounting topics covered.