Debit and Credit 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 debit column is on the left and the credit column is on the right.
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.
Debit and Credit 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 an 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.
Debit and Credit 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.
Debits and Credits in Common Accounting Transactions
The following bullet points note the use of debits and credits in the more common business transactions:
Sale for cash: Debit the cash account | Credit the revenue account
Sale on credit: Debit the accounts receivable account | Credit the revenue account
Receive cash in payment of an account receivable: Debit the cash account | Credit the accounts receivable account
Purchase supplies from supplier for cash: Debit the supplies expense account | Credit the cash account
Purchase supplies from supplier on credit: Debit the supplies expense account | Credit the accounts payable account
Purchase inventory from supplier for cash: Debit the inventory account | Credit the cash account
Purchase inventory from supplier on credit: Debit the inventory account | Credit the accounts payable account
Take out a loan: Debit cash account | Credit loans payable account
Repay a loan: Debit loans payable account | Credit cash account
Debit and Credit Examples
Arnold Corporation sells a product to a customer for $1,000 in cash. This results in revenue of $1,000 and cash of $1,000. Arnold must record an increase of the cash (asset) account with a debit, and an increase of the revenue account with a credit. The entry is:
Arnold Corporation also buys a machine for $15,000 on credit. This results in an addition to the Machinery fixed assets account with a debit, and an increase in the accounts payable (liability) account with a credit. The entry is:
|Machinery - Fixed Assets||15,000|
Other Debit and Credit Issues
A debit is commonly abbreviated as dr. in an accounting transaction, while a credit is abbreviated as cr. in the transaction.
Debits and credits are not used in a single entry system. In this system, only a single notation is made of a transaction; it is usually an entry in a check book or cash journal, indicating the receipt or expenditure of cash. A single entry system is only designed to produce an income statement.