Accounting, broadly considered, is the system of measuring, recording, and reporting economic events based on the accounting equation: Assets = Liabilities + Equity(also stated as: Assets - Liabilities = Equity).
Double-entry accounting is a self-balancing accounting method consisting of two-sided transactions that record where your money comes from and where it goes to. This is in contrast to single-entry accounting—your personal checkbook is a good example—in which money simply enters stage right (when you, say, deposit a paycheck) and exits stage left (when you write a check for groceries).
Rather, in double-entry accounting, money never simply appears; it is transferred from a source account (or accounts) to a destination account (or accounts). For instance, you might pay a software vendor from your checking account (Asset); that payment is also then entered in your infrastructure expenses account (Expense). Thus, you may track exactly where and how (and when) your assets are being used.
These money transfers, also known as transactions, are recorded as debits and credits. Every debit to one account must be matched by a credit to another, and vice-versa. Double-entry accounting uses a form called a T account, so called because the T shape separates the three elements of a transaction. Along the top of the T you'll find the name of the affected account; in the left column are debits, and in the right, credits.
Things to forget
Before we continue, you probably ought to forget everything you know about the terms debit and credit (unless you're an accountant); their everyday usage (i.e. debit and credit cards) will only confuse you. For that matter, forget what you think an account is.
Accounts are not containers of money that sit in your bank (though they can represent those, too).
Rather, at their most basic and abstract, accounts consist of a number (for identification), a name, a type, and a balance (more below).
Account Balances are the sum of the debit entries minus the sum of the credit entries in that account.
Types of accounts
There are five types of accounts: Asset, Liability, Equity, Income, and Expense. Income and Expense are sub-accounts under Equity, but they behave differently enough that they're worth treating on their own.
- Assets are things that you have (say, cash in the checking account, or maybe a building) or that someone is legally obligated to give you later (such as Accounts Receivable).
- Liabilities are monies that you are legally obligated to pay to someone else—like debts, accounts payable, or financial aid money not yet disbursed.
- Equity—or, for non-profits, Net Assets—is what remains of your Assets after deducting your Liabilities. If you have $100 in Assets and $25 in Liabilities, your Net Assets/Equity would be $75. In a for-profit business, the shareholders would have some interest in that equity. But in a non-profit context, Net Assets are more like an ongoing resource.
- Income refers to the revenues you take in during a given time period. Your income accounts might read thus: Graduate Tuition, Undergraduate Tuition, Fees, Room & Board.
- Expenses are the costs you incur during a given time period. Utility Bills, Faculty Salaries, Insurance—these are typical expense accounts. Tuition discounts are also considered an expense.
As mentioned before, transactions are financial events that transfer money by crediting one account and debiting another.
How do debits and credits work?
Debits represent either the addition of an asset or expense or the reduction of income or liability.
Credits, conversely, represent reductions to assets or expenses or an increase in income or liability.
The chart below shows how debits and credits affect different kinds of accounts.
- indicates an increase to the account; the side of the T on which increases are recorded is the normal balance.
- indicates a decrease to the account.
Throughout these Billing and Financial Aid articles, we'll explain how the various transactions work on the "back-end"—that is, to answer the question "Where will the debits and credits show up?"
Used along with a good fund-based accounting package, Populi will help manage your General Fund—in particular, your Accounts Receivable. Populi also has workflows in place that let you pay out Financial Aid (from any source), as well as reconcile bank deposits from student payments.
As it happens, double-entry accounting is governed by a silly little Greek god.