The Effect of Debits and Credits to Financial Statements - Assignment Example

Debits and credits provide a systematic method of recording transactions to enhance consistency and matching principles of accounting. If transactions are recorded in their respective accounts and in the right manner, consequently, financial statements will be consistent. What are debits and credits? How do these affect the accounting equation? Are debits always increases? Are credits always decreases In accounting, debits and credits are a systematic way of recording different financial transactions in books of account.

Credits and debts represent two sides of the same account. When a transaction occurred, the financial accountant must record this transaction in two respective accounts. In one account, the financial accountant record on the left side of that account, this is called a debit (Kieso, 2010, p. 178) In the other account, a record is made on the credit side of that account to meet standard accounting requirements. For example, if the company purchases a machine for $100,000 on credit from General motor company then recording made will have both a credit and a debit entry as follows: Debit: Machinery (asset) account with $ 100,000 Credit: General motor LTD account (Liability) with $100,000 When the business makes payment for this asset, then debit entry on the asset account must be made to reflect the payment.

Assuming payment was done in cash, then the transaction will be recorded as follows. Debit: machinery account (asset) with the amount paid Credit: Cash account (asset) Debits and credits have no effects on accounting equations since each entry balance either one side or both sides of the accounting equation. Debits do not always increase; it as well decreases in some books of the account such as capital and liabilities. Credits as well do not only decrease, but also increase revenues, liabilities and capital books of account.

Investors as an external user of financial statement In companies, investors are the key external users of financial statement. This statement provides a summary of the financial performance of the company for a certain accounting period. Very importantly, financial statement determines the financial position of the business. Investors extract important information from a financial statement that helps them in drawing important investment decision and trends in the near future (Welsch, et.al 2008, p. 135). This financial statement shows the trend in the past and future profitability of the firm and other necessary information in order to determine whether it is worth to undertake a certain investment.

Investors are shareholders of the company and need this statement to determine the effectiveness of management teams in utilizing the company’s resources. It also determines the honesty and transparency of the management since the document explicitly outlines revenues earned by the company and how this revenue was allocated. This statement helps to gauge the performance of different departments in the company. Before purchasing shares of a company, the financial statement provides the company’s summary, strengths, and weaknesses, which helps to guide investor's decision on whether to invest their capital in that company.