Debits and
Credits
Accountants have their own curious methods for referring to
changes on each side of the balance sheet. Traditionally, assets are shown on
the left and liabilities and capital are on the right. Dollar increases on the
left side are called debits. Increases on the right side
are called credits. Debits and credits are only allowed to be positive numbers; that is, one does
think of recording a negative debit. Debiting an asset always means increasing
its dollar value. To reduce an asset's dollar value, it is credited. No
particular connotation of good or bad should be assigned to the words debit and
credit; they are simply synonyms for dollar increases left and right.
There may be a question at this point. If negative numbers are not
used on the balance sheet, how do we keep track of things that have balances
that go up and down? Enter the "T" chart. We
set up a "T" chart for a specific asset, like cash, defining both a right and
left side on the cash "T" chart. (Refer to Figure 1-6 for an illustration.) We can then record all
credits on the right side of the "T" chart and then net them with the starting
balance and subsequent debits on the left side. Then, when it is time to compute
a new balance sheet, we record the new net amount on the left side of the
balance sheet for cash. "T" charts are not mini-balance sheets. They do not
convey an equation. Their left and right sides do not need to balance. They are
simply a recording mechanism, in chart form, for individual transactions, debits
and credits.
However, if cash has been credited, we also need a second change,
a debit, on the balance sheet to maintain the balance. If cash is to be
credited, then a liability must be debited (decreased) or another asset is
debited (increased). For example, we could use the cash to buy an asset and all
would be in balance. Again refer to Figure 1-6 to see how this is done.
Project managers in some companies are asked to review the monthly
"trial balance." The trial balance is a listing of all the debits and credits
recorded in a period. Naturally, they should balance. Of course, a debit or
credit could have been made to a wrong account and the trial balance still
balance. That is where the project manager can add value: by determining that
all the project debits and credits have been applied to the proper accounts.
Here is an important point: balance sheets do not record flows,
that is, a change in dollars over a period. They show only the balance in
accounts on a specific date, like apples in a
barrel. To see a flow, two balance sheets — one at period beginning and one at
period ending — need to be compared.
How about your ATM or "debit" card that you carry around? Is it
correctly named? Yes it is; let us see why. The money in your checking account
is a short-term liability on the bank's balance sheet. It is money owned by
outsiders (you) and thus it conforms to the definition of a liability. It
finances or pays for an asset of equal amount, the bank's cash on hand.
Everything is in balance. Suppose you want to take some of your money out of the
bank. This will decrease the bank's liability to you. Recall that transactions
to liabilities are credits (increases), so in order to decrease a liability we
record a debit to the liability. To wit: a decrease of a liability is a debit to
the liability; thus the "debit card." Now, of course, we still need the second
transaction to the balance sheet to maintain the balance. If the liability is to
be debited, then an asset must be credited (decreased), like the bank's cash on
hand, or another liability is credited (increased), like a short-term note, to
obtain the money to pay you.
Now that we understand a little bit about how accountants do
their math, let us get back to project management.
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