So, what is a Balance Sheet and how do we make sense of these debits and credits? Relax. It is very simple once you learn a few simple rules.
First, what is a Balance Sheet? It is most easily understood if you think of a picture taken with a camera. It is a moment of time frozen in which you see what all the balances were. It always has a specific date associated with it. It is a snapshot of a business or of the financial position of an individual at a given point in time.
So, what’s the “balance” part of it mean? Simple. It has 2 sides and the 2 sides (or top and bottom) always balance each other. They are the same totals of the things listed in them, on each side. So, what are these two things? Easy! It’s the two “views” of the business. Like a coin that has two sides, a business or any other entity has two ways to view it: on one side (the left side, or the top half) are listed all the assets owned by the business or the individual.
The other side (the right or the bottom half) shows who OWNS the assets of the business. Another way of saying “who owns” the assets is who has a claim on those assets? The balance comes as a result of the common sense idea that for every asset, someone owns or has a claim on that asset.
Left side is the debit side, right side is the credit side. In other words, items on the left side, the assets, normally have debit balances, things listed on the right side (liabilities and equity) normally have credit balances. In total, there always has to be as many credits as there are debits.
Note: The right side has two parts; the liabilities and the equity. Either someone outside the company has a claim of ownership (bank loans, vendors) on the assets or the owner of the company has a claim on what’s left- the equity. It’s like your house; the house itself is the asset, the mortgage is the liability, the difference between what it’s worth and what is owed is your equity. Your house value is listed as a debit on the left side, the bank loan as a credit balance on the right, and the difference is your equity (also a credit). The total of both sides equal. Debits = credits.
So, any increase of an asset has to be a debit since the asset side is the debit side. Any increase in liability or equity has to be a credit to be consistent with it’s right side position. Conversely, to decrease an asset, you credit it, to decrease a liability or equity you would debit it. See how simple?
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