The basics of debits and credits in accounting are important for small businesses to know. Learning about debit and credit accounting helps you keep your business records accurate and gives you a better picture of where your finances stand.
To do this, you must understand which account records debits and which account records credits, and how each of these accounts balances the other.
In this article, we discuss what debits and credits are in accounting, how they differ, and simple examples of debits and credits that you can refer to for more information.
A debit is a record in personal accounting that represents the money that goes into an account. In the company, accounting debits can lead to a decrease in liabilities or an increase in assets.
Debits are added to the left side of T accounts in double-entry accounting methods and are considered the opposite of accounting credits.
These accounts are usually increased with a debit:
A credit is an entry in accounting entries that will decrease an asset or expense account or increase a liability or equity account.
Credits are added to the right side of T accounts in double-entry accounting methods.
These accounts usually increase with a credit:
- Shareholders’ equity (owners)
Every time an accounting transaction takes place, at least two accounts are affected. There is no limit to the number of accounts that can be affected by a transaction, but at least two accounts will always be affected.
A debit is posted to one account and a credit to another. For financial statements to be accurate, each debit and credit must balance and have the same number of entries in the accounts they affect.
Before understanding how debits and credits work in accounting, you must first understand the accounts that are affected by debit and credit transactions.
Here are the common accounts that can be affected by debits and credits:
- Expenses: Any costs of business operations that occur, such as wages or supplies
- Assets: Items owned by a business that have economic value and can be sold for cash value, such as property, vehicles, or land
- Liabilities: The amounts that a company owes to another company, person or bank
- Equity: The assets of a company subtracted by the liabilities
- Revenue: The cash that results from sales
These are the rules that govern the use of credit and debit in accounting:
- When a debt is added to a debit balance, it generally increases the amount in all accounts and the amount decreases when a credit is applied to them. The rule is consistent with accounts such as expenses, assets, and dividends.
- When accounts have a credit balance, the amount increases when a credit is applied to them and decreases when a debit is applied. This rule is consistent with accounts such as income, liabilities, and equity.
- In a transaction, each amount of debits is required to equal the sum of the credits. If the account is unbalanced, it will not be accepted by the accounting software.
The reason debits and credits affect accounts differently is due to their underlying accounting equations since every accounting transaction begins with the basic accounting equation Assets = Liabilities + Equity.
Below is a table that summarizes how each debit and credit affects the accounts to which they are added:
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Here are some ways to use debit and credit operations in regular business transactions:
- Sale for money: The cash account is debited and the income account is credited
- Cash payment of an account receivable: The cash account is debited and the accounts receivable account is credited
- Supplies purchased from a supplier in exchange for money: The supplies expense account is debited and the cash account is credited
- Employee payroll: Payroll tax accounts are debited and the cash account is credited
- Sale on credit: Debtors account is debited and income account is credited
- Approved Loan Money: Cash account is debited and Loans Payable account is credited
- Repay the loan money: The loans payable account is debited and the cash account is credited
- Supplies purchased from a vendor on credit: The supplies expense account is debited and the payment account is credited
- Inventory purchased from a supplier with cash: The stock account is debited and the cash account is credited
- The purchase of inventory from a supplier on credit: The inventory account is debited and the accounts payable account is credited.
Here are some examples and visuals of how debits and credits work in a double-entry accounting method:
The Treetop Company sells a service to a customer for $3,000 in cash. The result of this transaction is that the company now has an increase in revenue of $3,000 and an increase in cash of $3,000. Treetop then records the increase as a debit by adding it to the cash or asset account. The business would then add a credit to the revenue account. The entry or transaction can be represented by the following table:
Credit Cash: $3,000
The Treetop Company is also purchasing a new building on credit for a price of $200,000. The result of this transaction adds a debit to the fixed asset account. The credit is added to the accounts payable or liability account, resulting in an increase in the account. The entry or transaction can be represented by the following table:
Credit Building Fixed Assets: $200,000
Account Liability: $200,000
Debit and credit are accounting terms that describe how money is transferred between two financial institutions. A debit means adding money to an account, and a credit means borrowing money from an account.
When a company pays someone with a debit card, the bank adds that amount of cash to the account. When the company borrows money from a bank, the bank credits the account with that much cash.