Bookkeepers and accountants use debits and credits to balance each recorded financial transaction for certain accounts on the company’s balance sheet and income statement. Debits and credits, used in a double-entry accounting system, allow the business to more easily balance its books at the end of each time period.
What Are Debits and Credits?
Debits, abbreviated as Dr, are one side of a financial transaction that is recorded on the left-hand side of the accounting journal. Credits, abbreviated as Cr, are the other side of a financial transaction and they are recorded on the right-hand side of the accounting journal. There must be a minimum of one debit and one credit for each financial transaction, but there is no maximum number of debits and credits for each financial transaction. The business’s Chart of Accounts helps the firm’s management determine which account is debited and which is credited for each financial transaction. There are five main accounts, at least two of which must be debited and credited in a financial transaction. Those accounts are the Asset, Liability, Shareholder’s Equity, Revenue, and Expense accounts along with their sub-accounts. A debit increases both the asset and expense accounts. The asset accounts are on the balance sheet and the expense accounts are on the income statement. A credit increases a revenue, liability, or equity account. The revenue account is on the income statement. The liability and equity accounts are on the balance sheet.
How Debits and Credits Work
When you pay a bill or make a purchase, one account decreases in value (value is withdrawn, which is a debit), and another account increases in value (value is received which is a credit). The table below can help you decide whether to debit or credit a certain type of account. Determining whether a transaction is a debit or credit is the challenging part. This is where T-accounts become useful. T-accounts are used by accounting instructors to teach students how to record accounting transactions.
How Do You Record Debits and Credits?
For Journal Entries
Each T-account is simply each account written as the visual representation of a “T. " For that account, each transaction is recorded as debit or credit. This information can then be transferred to the accounting journal from the T-account. The T-accounts for the example of the electric utility payment in Table 2 would look like this:
Asset Accounts
Assets consist of items owned by a company, such as inventory, accounts receivable, fixed assets like plant and equipment, and any other account under either current assets or fixed assets on the balance sheet. Debits are increases in asset accounts, while credits are decreases in asset accounts. In an accounting journal, increases in assets are recorded as debits. Decreases in assets are recorded as credits. Here’s an example. A company buys a large quantity of inventory to gear up for holiday sales. Inventory is a current asset, and the company pays for the inventory with cash. The company purchases $10,000 in inventory. The journal entry would look like this: Here is a tip about how to handle the cash account: If the company decided to sell a building for $250,000 and it received cash for the property, the journal entry would look like this:
Liability Accounts
Liabilities are what the company owes to other parties. They can be current liabilities, like accounts payable and accruals, or long-term liabilities, like bonds payable or mortgages payable. If a company has a bank loan and makes a $5,000 payment, here is an example of the journal entry:
Owner’s Equity Accounts
The owner’s equity accounts are also on the right side of the balance sheet like the liability accounts. Examples are common stock and retained earnings. They are treated exactly the same as liability accounts when it comes to accounting journal entries. Here is an example of a journal entry for the owner’s equity account. A business has two owners and one owner wants to invest an additional $50,000 in the business. The common stock of the business is selling at its par value. Here’s the resulting journal entry:
Expense Accounts
Expense accounts are items on an income statement that cannot be tied to the sale of an individual product. Of all the accounts in your chart of accounts, your list of expense accounts will likely be the longest. Expense accounts run the gamut from advertising expenses to payroll taxes to office supplies. It’s imperative that you learn how to record correct journal entries for them because you’ll have so many. Here’s an example of a business transaction involving an expense account and the resulting journal transaction. A company purchases $750 in office supplies using cash. Here’s the resulting journal entry:
Revenue or Income Accounts
Revenue accounts are on a company’s income statement. A company’s revenue usually includes income from both cash and credit sales. A company can also have revenue from investments. Larger companies sometimes invest in other companies. Smaller firms invest excess cash in marketable securities which are short-term investments. Here is a sample journal entry for a revenue transaction. A small business has $5,000 in cash sales on a given day. Here’s how those sales, which are revenue for the firm, would be recorded: These steps cover the basic rules for recording debits and credits for the five accounts that are part of the expanded accounting equation.
