Debits and credits are the opposing sides of an accounting journal entry. They are used to change the ending balances in the general ledger accounts. The rules governing the use of debits and credits in a journal entry are as follows:
- Rule 1: 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.
- Rule 2: 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.
- Rule 3: Contra accounts reduce the balances of the accounts with which they are paired. This means that (for example) a contra account paired with an asset account behaves as though it were a liability account.
- Rule 4: The total amount of debits must equal the total amount of credits in a transaction. Otherwise, a transaction is said to be unbalanced, and the financial statements from which a transaction is constructed will be inherently incorrect. An accounting software package will flag any journal entries that are unbalanced.
By following these debit and credit rules, you will be assured of making entries in the general ledger that are technically correct, which eliminates the risk of having an unbalanced trial balance. However, just following the rules does not guarantee that the resulting entries will be correct in substance, since that also requires a knowledge of how to record transactions within the applicable accounting framework (such as Generally Accepted Accounting Principles or International Financial Reporting Standards).