I doubt you will need to know double entry accounting, but the basics might help so you have an idea why people are getting so worked up about what seem like an arbitrary choices.
Double Entry Accounting Basics:
‘Double’ entry refers to Credits and Debits. Every entry will have a credit and a debit. (Single entry is what most people do with a checkbook or savings account. Every transaction is a single positive or negative number.)
A credit is NOT a positive entry nor is a debit a negative entry. If you like words, think of it this way: it’s to your credit to go down on an ass. Of course, an ass is an asset.
If you look at “the books” on a balance sheet, you will have two sides that are always in balance; assets on the left, liabilities and equity on the right. The two sides are always in balance because the balance sheet is like a teeter-totter.
What happens on the right side of the teeter-totter is the opposite of what happens on the left side. Going down on a liability is a debit.
A real quick transaction… cash is an asset. It is immediately available, so it goes at the top of your asset list on the left. Inventory is also an asset, but you have to sell it before you can realize a profit (equity) or get your cash back from it, so it goes at the bottom of your asset list. If you spend cash to buy inventory, you enter a credit to cash (which goes down because you have less of it) and a debit to inventory. Note that the credit and the debit are on the same side of the balance sheet.
Often, a company will borrow money to buy inventory. Because the money needs to be repaid, it is a liability. In this case, the money goes into cash: a debit (cash goes up). The corresponding credit is to Loan #1 which is a new liability which also goes up. For this transaction, the credit and the debit are both positive. They are also on opposite sides of the balance sheet.
The borrowed money will need to be paid back over time, let’s say five years. There are also other liabilities such as the phone bill which needs to be paid every month. The loan is long term debt and goes at the bottom of the liability list.
When the phone bill is paid, the transaction goes like this: cash goes down (a credit) and phone bill goes down (a debit). When cash is spent on office supplies, for example, that is an expense. Cash goes down and expenses go up. (Expenses go on the right side of the balance sheet.) Expenses and short term liabilities are cash leaving the business.
Since this is already overlong, I’ll just try to finish with this. Businesses try to avoid paying short term liabilities and expenses with long term debt. Cash that is spent on long term assets — items that last more than one year — is handled as though some portion of it is being spent every month over the lifetime of the asset rather than all at once. The asset depreciates over its useful lifetime.
Classifying transactions accurately is a huge part of managing a business.
For example, as a business does more business it costs more to buy more inventory (or pay more salary or buy more fuel or whatever) so there is less cash, but accounts payable (an asset) goes up. Unfortunately, accounts payable takes awhile to become cash. So the balance sheet balances — it always does — but the business is going to need an influx of cash to stay in business. A lot of start up businesses crash because of that fact. They have tons of sales, but no cash.
