One of the most confusing phrases in accounting jargon is “debits and credits.” What does it mean to debit an account or to credit one? How is it that debiting some accounts causes the numbers to go up? But debiting other types of accounts makes the numbers go down? Why is knowing how debits and credits work even important to your company? Here is a basic look at debits and credits in accounting.
What are Debits and Credits?
Debits and credits are terms used by accountants and bookkeepers when recording transactions in a company’s accounting records. They are two separate transactions and have their own definition.
- Debits are accounting entries that increase an expense or asset account or decrease an equity or liability account. Debits are entered to the left in an accounting entry.
- Credits are accounting entries positioned in the right-hand column in an accounting entry. A credit increases an equity or liability account or decreases an expense or asset account.
What Accounts Can be Impacted by Debits and Credits?
Debits and credits are equally important to a company’s accounting and bookkeeping practices. However, they are opposite entries in the books. If a debit is recorded, and it increases an account, a credit entry will decrease the opposite account. Debits affect asset and expense accounts by increasing them and decreasing revenue, equity, and liability accounts. Credits influence asset and expense accounts by decreasing them while increasing equity, revenue, and liability accounts.
What are the Uses of Debits and Credits?
Debits and credits are used to record transactions in bookkeeping to balance the books. Debits and credits are used inside a two-column recording format and provide control over accounting accuracy. They affect accounts differently, but ultimately keep transactions balanced. Debits and credits impact at least two accounts, but there is no limit to the number of accounts that may be involved in a transaction. There are five basic types of accounts in which debits and credits are recorded, including
- Revenue or Income
How Debits and Credits Affect Liability Accounts
Liability accounts reflect what the business owes. These incurred expenses have not been paid yet. Some accounts categorized as liability accounts include:
- Payroll Tax
- Sales Tax
- Credit Memo
- Accounts Payable
Liability accounts are increased by credits and decreased by debits.
How Debits and Credits Affect Equity Accounts
An equity account shows how much a business or company is worth. It is the difference between its assets and liabilities. Some examples of equity accounts include:
- Owner Equity
- Retained Earnings
- Common Stock
Equity accounts are increased by credits and decreased by debit entries.
How Debits and Credits Affect Asset Accounts
A business’ assets include tangible or intangible property that adds value to the company. Some examples include business vehicles, computers, and trademarks. A few examples of asset accounts may include:
- Checking accounts
- Petty Cash
- Accounts Receivable
Debit entries increase asset accounts, while credit entries cause a decrease.
How Debits and Credits Affect Expense Accounts
The costs a business incurs during its operations are expenses. Utilities, rent, or mortgage for a building, and office supplies are examples of expenses. Some of a company’s expense accounts include:
- COGS (Cost of Goods Sold)
Expense accounts are increased by debits and decreased by credits.
How Debits and Credits Affect Income Accounts
Income or revenue accounts are the money a business earns or has come in. Income accounts keep track of money that comes in from operations and non-operations. Some income account examples include:
- Product Sales
- Miscellaneous Income
- Earned Interest
Credits increase revenue accounts, and debits decrease income accounts.
What are Examples of Debits and Credits?
Debits and credits are essential elements in record-keeping and accounting. To get a better understanding, let’s take a look at a couple of examples.
- A company sells three items to a customer for $900. The transaction is immediate and in cash. The company deposits the money into its business account. To update the account records, the $900 transaction is recorded as a debit to the cash account and credited to the revenue account.
- A business takes out a $3000 loan to upgrade its store. The liabilities account is debited for $3000, and the cash account (assets) is credited the same amount.
- A contractor decides to purchase new equipment for $10,000. Equipment is an asset, so the cost will be added as a debit of $10,000 to the fixed asset account. But he also increased his liabilities, so his accounts payable account is credited with the $10,000.
What is the Difference Between a Debit and a Credit?
Accurate accounting depends on the proper handling of debits and credits. They are essential for preparing financial records, statements, and other documents to share with third parties like banks, the IRS, or your accountant. Here is a brief look at how the two differ.
- Debits increase when credits decrease, and vice versa.
- Debits are recorded on the left column of an account, while credits are recorded on the right side.
- Debits increase expense and asset accounts, while credits increase revenue, equity, and liability accounts.
- Debits decrease revenue, equity, and liability accounts, while credits decrease expense and asset accounts.
What is the Debits and Credits Chart?
Many people use a chart to help them record debits and credits accurately. The debits and credits chart organizes information and makes an easy-to-read cheat sheet so that remembering debits and credits in accounting is easier.
|Increases asset accounts
|Decreases asset accounts
|Increases expense accounts
|Decreases expense accounts
|Decreases liability accounts
|Increases liability accounts
|Decreases equity accounts
|Increases equity accounts
|Decreases revenue accounts
|Increases revenue accounts
|Always recorded on the left side
|Always recorded on the right side