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Debits and Credits MADE EASY with ADEx LER - YouTube
Channel: Leila Gharani
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If you want to learn accounting
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the concept of debits and credits
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is one of the most
important to understand.
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But, many struggle with it
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and for me it was the
same in the beginning
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because it's not something
that's completely explainable
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with logic.
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But, I managed to understand it
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and by the end of the video, so will you.
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(synthesizer music)
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In accounting, debits and
credits always go together.
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Every transaction will
have debits and credits
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and at least two accounts
will be affected.
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So remember, one transaction
affects two accounts.
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If one account is debited,
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then the other one must be credited.
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Just think of it like a bank transfer.
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When you send someone money,
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it comes out of your bank account
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and it goes into their account.
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In accounting, instead
of these piggy banks
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we use T accounts.
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Every account has it's own T.
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The left side of the T
is where the debits go.
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Credits go on the right side.
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That's already the first main
rule you have to remember.
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Debit and credit do
not mean plus or minus.
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It literally just means
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debit goes to the left side of a T account
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and credit goes to the
right side of a T account.
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Debit means left, credit means right.
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That's rule number one.
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The second important rule
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is that for every transaction,
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the total amount of debits must equal
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the total amount of credits.
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If you debit an account for 100,
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you must credit another one with 100.
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There can be more than two accounts
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involved in a transaction,
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but never less than two.
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That's rule number two.
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Now, the third rule usually
creates a lot of confusion,
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but you'll be fine because I
have a secret weapon for you.
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More on that later.
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Before we dive right in,
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let's do something else first
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that we'll need in the process,
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and that's to figure out
the balance in a T account.
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The balance is basically
the total of an account.
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So, let's say we have these
two accounts visualized at T's.
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Then, we record some transaction to them.
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First, account number
one gets a debit of 500,
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and account number two
gets a credit of 500.
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For the second transaction,
account number two
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gets a debit of 100 and account number one
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gets a credit of 100.
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With that, we successfully
applied the first two rules
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of debit and credit.
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We put debits on the left
side of the accounts,
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credits on the right side.
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And, for each transaction
the total of debit and credit
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was the same, so far so good.
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Now to calculate the balance
or total for the accounts,
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we add up the amounts on
the debit and credit side
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for each account separately.
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Account number one has
500 on the debit side
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and 100 on the credit side.
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We deduct the smaller sum of credits
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from the bigger total of debits
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which gives us 400.
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In accounting, we call this
a debit balance of 400.
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For account number two, it's the opposite.
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It has a credit total of 500
and total debits are 100.
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Again, we deduct the smaller
one from the bigger one,
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account number two has
a credit balance of 400.
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Here comes the confusing part.
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Let's say we have another transaction
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that adds another debit of
50 to account number one
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and one more transaction
with a debit of 100
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going to account number two.
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Let's just say the credits
for these transactions
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go to different accounts.
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We don't need to worry
about these for now.
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What would happen is that the balance
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of account number one would increase
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while the total of account
number two decreases.
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Both received a debit,
but one account increases
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while the other one decreases.
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They are behaving differently.
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And, that's rule number three.
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It depends on the account
if a debit or a credit
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increases the balance
or if it decreases it.
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And, that's really the secret
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to understanding debit and credit.
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Like we saw in our example,
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the balance of account number
one increases with the debit
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while the balance of account
number two decreases.
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You may ask, well how do
you know which one it is?
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Fortunately, there are only
two groups to remember.
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The first group includes assets,
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that's the resources the
company owns and uses,
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like buildings, machines,
equipment and so on.
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Dividends, that's when
the company distributes
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it's profit and cash to the owners.
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And expenses, that's money
we pay for goods or services
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the business purchased.
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All accounts in this group are debits,
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which means that their balance
will usually be a debit.
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Therefore, the total of these accounts
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will increase when they get another debit
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and will decrease with
they get another credit.
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So, account number one
in our previous example
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would be in this group.
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The second group includes liabilities,
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which is money we still owe to others,
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like to the bank, to
suppliers or to the IRS.
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Owner's equity, that's the
money the owners of the company
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put into the business.
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And revenue, that's the money we receive
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for sales to our customers.
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All accounts in this group are credits
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which means that their balance
will usually be a credit.
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Therefore the total of
these accounts will increase
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when they get another credit
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and will decrease when
they get another debit.
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So, account number two
in our previous example
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would be in this group.
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And, that's rule number three.
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It's really important
that you memorize this
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because to record any transaction,
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you have to answer two questions.
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Which accounts are affected?
Did accounts go up or down?
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We will cover this in more
detail in the next video,
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but just so you know
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that in order to answer
question number two,
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you need to understand if an account
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is a debit or a credit account.
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If you have trouble remembering this,
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just think of ADEx LER,
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Accountants don't expect
low earning rates.
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Assets, dividends, expenses,
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liabilities, equity, and revenue.
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ADEx are debits.
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The balance of these accounts
increases with debits
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and decreases with credits.
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So, let's take cash for
example. Cash is an asset.
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So, it resides on the
debit side of our equation.
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When you take money out of your
account to pay for something
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you reduce your cash balance.
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And, remember our rule, the
balance on the debit side
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increases with debit and
decreases with credit.
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So, do we debit or
credit the case account?
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We credit it because we reduce it.
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LER are credits.
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The balance of these accounts
increases with credits
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and decreases with debits.
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Take a loan, for example,
which is a liability.
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When you take out a higher loan,
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you credit the loan account.
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When you pay back a loan, what do you do?
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You debit the loan account,
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which will reduce it's balance.
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So, that's really all there is to it.
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All you have to remember
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is accountants don't
expect low earning rates.
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ADEx LER.
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Assets, dividends, expenses,
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liabilities, equity and revenue.
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This will help you determine
debit and credit accounts.
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Just practice it and it's eventually
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going to become second nature to you.
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In the end, you're not
even going to have to think
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about it anymore.
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Wait a minute.
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How does my debit card
fit into this definition?
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One more thing regarding
debits and credits.
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I just want to clear this up
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because it creates confusion
for a lot of people.
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The reason for the confusion are banks
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and how we talk to them.
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For instance, when you
put money in your account
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the bank will credit it.
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When you take money out of your account,
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they will debit it.
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A debit card is issued for the purpose
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of accessing your funds
and to take money out
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from your account.
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Now, if you think about this,
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it really seems like
it's exactly the opposite
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from what we just learned.
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Cash is an asset.
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And, according to ADEx LER,
resides on the debit side
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of the account equation.
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And, therefore, increases with a debit.
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If you're adding money, you will debit it,
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and if you're taking money
out, it will be credited.
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So, why is this backwards with banks?
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Do the general rules of
accounting not apply to them?
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Actually, they do,
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but they look at it
from their point of view
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not yours.
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Think about that.
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When you put money in
your checking account,
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it belongs to you, not to the bank.
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The bank just holds it for you.
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So, for the bank, this
money really is a liability,
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because at some point,
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they're going to have
to pay it back to you.
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According to ADEx LER,
liabilities are on the credit side
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of the equation, right?
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And, to increase a liability,
you will have to credit it.
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Therefore, the bank
will credit your account
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when you put money in it.
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Likewise, when you buy
stuff with your debit card,
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this will reduce the
balance in your account.
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The bank owes you less money.
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Therefore, it will be debited
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and hence the name, debit card.
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So, this is why it seems backwards.
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The same accounting rules
apply to banks as well
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as to any other business in the world.
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The terminology they use may be confusing
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because it's from the
point of view of the bank
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and not from your point of view.
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So, you might ask, what
about credit cards?
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Well, if you're issued a credit card,
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the bank or the provider of the card,
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is providing a line of credit to you.
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In other words, credit cards
combine payment services
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with the extension of credit.
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And, like for any loan, you're
going to be charged interest,
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actually very high interest,
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for the balance you carry
over from month to month.
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In addition, credit cards may offer
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additional insurance on purchases
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or make it easier to request
a refund or a return.
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But, in the end, it's main purpose is to
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award you a line of
credit or credit limit,
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hence the name.
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I hope this was helpful
to avoid confusion.
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Please just stick to the definitions
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of debits and credits that we just learned
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and always remember ADEx LER
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and you're going to be fine.
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If you enjoyed this video,
give it a thumbs up.
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And, if you want to improve your skills,
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consider subscribing.
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And, don't forget to hit that bell
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so you don't miss out when
I put out new videos here.
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Thank you for watching.
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See you in the next video.
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(upbeat music)
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