Debits and Credits Definitions
Business transactions are events that have a monetary impact on the financial statements of an organization. When accounting for these transactions, we record numbers in two accounts, where the debits column is on the left and the credits column is on the right.
- A debit is an accounting entry that either increases an asset or expense account or decreases a liability or equity account. It is positioned to the left in an accounting entry.
- A credit is an accounting entry that either increases a liability or equity account or decreases an asset or expense account. It is positioned to the right in an accounting entry.
What are debits and credits?
Debits and credits are terms used by bookkeepers and accountants when recording transactions in the accounting records. The amount in every transaction must be entered in one account as a debit (left side of the account) and in another account as a credit (right side of the account). This double-entry system provides accuracy in the accounting records and financial statements.
The initial challenge is understanding which account will have the debit entry and which account will have the credit entry. Before we explain and illustrate the debits and credits in accounting and bookkeeping, we will discuss the accounts in which the debits and credits will be entered or posted.
Debits and credits T chart
This is a basic template of how you would record debits and credits as a journal entry:
Debits and Credits Usage
Whenever an accounting transaction is created, at least two accounts are always impacted, with a debit entry being recorded against one account and a credit entry being recorded against the other account. There is no upper limit to the number of accounts involved in a transaction – but the minimum is no less than two accounts.
The totals of the debits and credits for any transaction must always equal each other so that an accounting transaction is always said to be “in balance.” If a transaction were not in balance, then it would not be possible to create financial statements. Thus, the use of debits and credits in a two-column transaction recording format is the most essential of all controls over accounting accuracy.
There can be considerable confusion about the inherent meaning of a debit or a credit. For example, if you debit a cash account, then this means that the amount of cash on hand increases. However, if you debit accounts payable account, this means that the amount of accounts payable liability decreases. These differences arise because debits and credits have different impacts across several broad types of accounts, which are:
- Asset accounts. A debit increases the balance and a credit decreases the balance.
- Liability accounts. A debit decreases the balance and a credit increases the balance.
- Equity accounts. A debit decreases the balance and a credit increases the balance.
The reason for this seeming reversal of the use of debits and credits is caused by the underlying accounting equation upon which the entire structure of accounting transactions are built, which is:
Assets = Liabilities + Equity
Thus, in a sense, you can only have assets if you have paid for them with liabilities or equity, so you must have one in order to have the other. Consequently, if you create a transaction with a debit and a credit, you are usually increasing an asset while also increasing a liability or equity account (or vice versa). There are some exceptions, such as increasing one asset account while decreasing another asset account. If you are more concerned with accounts that appear on the income statement, then these additional rules apply:
- Revenue accounts. A debit decreases the balance and a credit increases the balance.
- Expense accounts. A debit increases the balance and a credit decreases the balance.
- Gain accounts. A debit decreases the balance and a credit increases the balance.
- Loss accounts. A debit increases the balance and a credit decreases the balance.
If you are really confused by these issues, then just remember that debits always go in the left column, and credits always go in the right column. There are no exceptions.
Debits and Credits Rules
The rules governing the use of debits and credits are as follows:
- All accounts that normally contain a debit balance will increase in amount when a debit (left column) is added to them and reduced when a credit (right column) is added to them. The types of accounts to which this rule applies are expenses, assets, and dividends.
- All accounts that normally contain a credit balance will increase in amount when a credit (right column) is added to them and reduced when a debit (left column) is added to them. The types of accounts to which this rule applies are liabilities, revenues, and equity.
- The total amount of debits must equal the total amount of credits in a transaction. Otherwise, an accounting transaction is said to be unbalanced, and will not be accepted by the accounting software.
Summary of debits and credits
You must have a grasp of how debit and credits work to keep your books error-free. Accurate bookkeeping can give you a better understanding of your business’s financial health. Debits and credits are used to prepare critical financial statements and other documents that you may need to share with your bank, accountant, the IRS, or an auditor.
Check out a summary of the key points regarding debit and credits.
- Debits increase as credits decrease.
- Record on the left side of an account.
- Debits increase asset and expense accounts.
- Debits decrease liability, equity, and revenue accounts.
- Credits increase as debits decrease.
- Record on the right side of an account.
- Credits increase in liability, equity, and revenue accounts.
- Credits decrease asset and expense accounts.
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