Sir Isaac Newton’s third law of motion, the law of reciprocal actions, states that for every action there is an equal and opposite reaction. The same can be said of accounting. For every financial transaction, there are two sides. There is a debit side and a credit side. For each transaction, these sides must be equal for your books to balance.

To understand double entry bookkeeping, you must first understand what is a debit and what is a credit. Simply put, a debit is something you own or money owed to you, and a credit is money you owe someone else. Let’s look at this in terms of the different types of accounts a business has.

Assets: These are debit items as they are items that are owned by the company. An increase in assets is a debit and a decrease in assets is a credit.

Liabilities: These are credit items, as they are items that the business owes to someone else. An increase in liabilities is a credit and a decrease in liabilities is a debit.

Owner’s Equity – This is a credit account because the owner’s equity account balance is money the business owes the business owner. An increase in owner’s equity is a credit and a decrease in owner’s equity is a debit.

Expenses: These are debit items because purchasing an expense item reduces an asset item (for example, cash in the bank) which is the credit site of the transaction.

Income – These are credit items because receipt of income increases an asset item (for example, cash in the bank) which is the debit side of the transaction.

Let’s see a simple example:

Let’s say you want to go to the store to buy a bottle of milk, which costs $3. Your purchase of milk is a financial transaction. Before you go to the store, you own $3, so this is a debit item, which is balanced by owner’s equity.

When you go to the store and pick up the bottle of milk, you now have a bottle of milk, worth $3, and you owe the store owner $3. Therefore, the bottle of milk is a debit and the $3 you owe is a credit.

When you pay the store owner for the bottle of milk, you are reducing the amount of money you own (the debit item will be credited) and you are reducing the amount of money you owe (the credit item will be debited).

Please note that at each transaction step, the debit and credit of the transaction are equal and the balance of all accounts has the same debit and credit.

So what happens when you drink the bottle of milk? You no longer have a $3 bottle of milk; you have an empty bottle that is worthless! That’s why we have expense accounts. Assets, which are debit items, are things that the business owns over a long period of time. Expenses, which are also debit items, are things that the company owns for a short period of time before they are used up.

That’s why we have two separate main reports for one company. The balance sheet is used for those items that are constant in a business. The Profit and Loss Statement (or Income and Expense Statement) is used for items that enter and leave a business on a regular basis. The balance resulting from the profit and loss statement is placed in the equity section of the balance sheet to even things out.

Another report you may have heard of is the trial balance. This is used to make sure you haven’t made a mistake before preparing your balance sheet and profit and loss statement. At the end of an accounting period, the closing balance of all your accounts (assets, liabilities, owner’s equity, expenses, and income) is included on this report to ensure that your debits equal your credits. If they don’t, you know you’ve made a mistake somewhere, and you’ll need to find your mistake before preparing the main reports. The flow column total should equal the flow column total.