Debits and credits are terms used by bookkeepers and accountants when recording transactions in the accounting records. The amount in every transaction must be entered in one account on the left as a debit and in at least one other on the right as a credit. This is double-entry bookkeeping – for accuracy in the accounting records, used for managing the business and producing the financial statements (for investors amongst others).

But which account gets the debit entry and which the credit entry? First, let’s look at the accounts where debits and credits are entered or “posted” and T-bars that aid communication….

1.2 What Is An Account?

Account are a way of organising all the transactions into groups, or “accounts” or “ledgers”. When a company's accounting system is set up, the accounts most likely to be needed are identified and listed out in the chart of accounts.

Within the chart of accounts the balance sheet accounts are listed first, followed by the income statement accounts:

1.3 Double-Entry Accounting

“Double” because every business transaction affects at least two accounts.

For example, when a company borrows 1,000, the transaction will hit the company's Cash account (as a debit) and Notes Payable account (credit). Then monthly repayments will come out of cash (credit), debit Notes Payable to reduce the balance due, but also there will be a third account: Interest Expense to increase, debit.

Accounting software will automatically reduce your Cash account and the prompt you for the other accounts.

1.4 Debits and Credits

To debit an account means to enter an amount on the left side of the account. To credit an account means to enter an amount on the right side.

Generally, these accounts are increased with a debit:

Dividends (Draws)
Expenses
Assets
Losses

D - E - A - L are increased with a debit.

Generally, the following types of accounts are increased with a credit:

Gains
Income
Revenues
Liabilities
Stockholders' (Owner's) Equity

G - I - R - L - S are increased with a credit.

The abbreviation for debit is dr. and the abbreviation for credit is cr.

	ASSETS	LIABILITIES	EQUITY	REVENUE	EXPENSES
DEBIT	↑ increase	↓ decrease	↓ decrease	↓ decrease	↑ increase
CREDIT	↓ decrease	↑ increase	↑ increase	↑ increase	↓ decrease

DC ADE LER

After doing a few T-bars, it will come intuitively.

Up to you how you remember …

2 T-Accounts

T-bars are a great visual aid to see the effect of a transaction or journal entry.

Take out and repay a loan – hits accounts Cash and Notes Payable.

1. Receive a loan, increase cash, increase loans repayable - Debit Cash, Credit Notes Payable:

2. Repay the loan, decrease cash, decrease notes payable – Credit Cash, Debit Notes Payable

2.1 Journal Entries

Those are T-bars, but you can visualise business transactions vy writing general journal entries. Look at what is required for a JE.

2.2 When Cash Is Debited and Credited

To set off on the right foot, memorise the following:

Whenever cash is received, debit Cash.
Whenever cash is paid out, credit Cash.

Imagine that a company receives $500 from a customer who was given 30 days in which to pay. (Previously, the company had recorded the sale and an accounts receivable.) So the company will debit Cash, because cash was received. The amount of the debit and the credit is $500. The general journal format is:

Which account is to be credited? Since this was the collection of an account receivable, the credit should be Accounts Receivable. (Because the sale was already recorded, you cannot enter Sales again.)

Whenever cash is paid out, the Cash account is credited (and another account will have to be debited).

3 Normal Balances

Where would you look in an account to see how much is in it? When looking at an account in the general ledger, or GL, you would normally find the debit or credit balance here:

3.1 Revenues and Gains Are Usually Credited

Revenues and gains are recorded in accounts such as Sales, Service Revenues, Interest Revenues (or Interest Income), and Gain on Sale of Assets. These accounts normally have credit balances that are increased with a credit entry. In a T-account, their balances will be on the right side.

However, the exceptions to this rule are whare called “contra accounts”, contra = against. Sales Returns, Sales Allowances, and Sales Discounts - these accounts have debit balances because they are reductions to sales.

For example, if you perform a service and immediately get paid the full amount $50:

The asset account Cash is debited and the revenue account Service Revenues will immediately be credited, increasing its account balance, because you completed the service and were paid all at the same time.

But if a company performs a service on credit? (i.e., the company allows the client to pay for the service at a later date, such as 30 days from the date of the invoice).

At the time the service is performed the revenues are considered to have been earned and so they are recorded in the revenue account, Service Revenues, with a credit. The other account involved cannot be the asset Cash as cash was not received.

The account to be debited is the asset account Accounts Receivable, en attendant. If the amount of the service performed is $400, the entry in journal entry JE format is:

Accounts Receivable, as an asset account, and is increased with a debit; Service Revenues, a revenue account, is increased with a credit.

3.2 Expenses and Losses are Usually Debited

Expenses normally have debit balances and are increased with a debit entry. Since expenses are usually increasing, think "debit" when expenses are incurred. (We credit expenses only to reduce them, adjust them, or to close the expense accounts.) Examples of expense accounts include Salaries Expense, Wages Expense, Rent Expense, Supplies Expense, and Interest Expense. In a T-account, their balances will be on the left side.

For example, pay $800 to the landlord for rent:

(Debits before credits in JE format, credit is indented.)

Cash is credited and Rent Expense is debited. (If the payment was made in advance of the month, the debit would go to the asset account Prepaid Rent.

To increase an expense account, debit the account.

3.3 Permanent and Temporary Accounts

Asset, liability, and most owner/stockholder equity accounts are referred to as "permanent accounts" (or "real accounts"). Permanent accounts are not closed at the end of the accounting year; their balances are automatically carried forward to the next accounting year.

"Temporary accounts" (or "nominal accounts" they are also called) include all the revenue accounts, expense accounts, the owner's drawing account, and the income summary account. Usually, the balances in temporary accounts increase throughout the accounting year. Then at the end of the accounting year the balances are transferred to equity - the owner's capital account or a corporation's retained earnings account.

By transferring out the balances on temporary accounts at the end of the accounting year, each temporary account will have a zero balance for when the next accounting year begins. Ie, the new accounting year starts with no revenue amounts, no expense amounts, and no amount in the drawing account.

It is by having many revenue accounts and many many expense accounts that a company is able to report detailed info on revenues and expenses throughout the year.

4 Bank's Debits and Credits

When you hear your banker say, "I'll credit your bank account," it means the transaction will increase your checking account balance. Conversely, if your bank debits your account (e.g., takes a monthly service charge from your account) your account balance decreases.

We learned that debiting the Cash account in the general ledger GL increases its balance, yet your bank says it is crediting your bank account to increase its balance ???

4.1.1 Transaction #1

Let's say that your company, Debris Disposal, receives $100 of currency from a customer as a down payment for a future site clean-up service. When the money is received, your company makes the following entry:

(Debris Disposal's journal entry)

Debris Disposal increases Cash account with a debit of $100. Since the company has not yet earned the $100, it cannot credit a revenue account. Instead, the liability account Unearned Revenues is credited - Debris Disposal has a liability to do the work (or to return the $100). Note: an alternate title for the Unearned Revenues account is Customer Deposits.

Now let's say you take that $100 to Trustworthy Bank and deposit it into Debris Disposal's bank account. Since Trustworthy Bank is receiving cash, the bank debits its general ledger Cash account for $100, increasing the bank's assets. The rules of double-entry accounting require the bank itself to also enter a credit of $100 into another of the bank's general ledger accounts. Because the bank has not earned the $100, it cannot credit a revenue account. Instead, the bank credits a liability account such as Customers' Bank Accounts, reflecting the bank's obligation/liability to return the $100 to Debris Disposal on demand.

In general journal format, these are the JEs the bank makes to record this transaction:

As the entry shows, the bank's assets increase by the debit of $100 and the bank's liabilities increase by the credit of $100. And in the bank's detailed records, Debris Disposal's current account is the specific liability that increased.

4.1.2 Transaction #2

Now let's say Trustworthy Bank receives a $1,000 transfer on your company's behalf from a person who owes money to Debris Disposal. Two things happen at the bank:

The bank receives $1,000, and

The bank records its obligation to give the money to Debris Disposal on demand.

Trustworthy Bank's journal entries:

The debit increases the bank's assets by $1,000 and the credit increases the bank's liabilities by $1,000. (And the bank's detailed records show that Debris Disposal's current account is the specific liability that increased.)

At the same time, the $1,000 transfer is received at the bank, Debris Disposal makes the following entry into its general ledger:

(Debris Disposal's journal entry)

As a result of collecting $1,000 from one of its customers, Debris Disposal's Cash balance increases and its Accounts Receivable balance decreases.

4.1.3 Transaction #3

Many banks charge a monthly fee on checking accounts. If Trustworthy Bank decreases Debris Disposal's current account balance by $13.00 to pay for the bank's monthly service charge, this might be itemized on Debris Disposal's bank statement as a "debit memo" – the bank gets the money so it is a debit from the bank’s point of view.

The entry in the bank's records will show the bank's liability being reduced (because the bank owes Debris Disposal $13 less). It also shows that the bank earned revenues of $13 by servicing the checking account.

The Bank's GL general ledger:

On your company's records, par contre, the entry will look like this:

Debris Disposal's GL general ledger:

Debris Disposal's cash is reduced with a credit of $13 and expenses are increased with a debit of $13. (Note: if the amount of the bank's service charges is not significant a company may debit the charge to Miscellaneous Expense.)

4.2 Bank's Balance Sheet

Accounts such as Cash, Investment Securities, and Loans Receivable are reported as assets on the bank's balance sheet. Customers' bank accounts are reported as liabilities and include the balances in its customers' checking and savings accounts as well as certificates of deposit. In effect, your bank statement is just one of thousands of subsidiary records that account for millions of dollars that a bank owes to its depositors.

4.3 Recap

Recapping so far:

· Debit means left

· Credit means right

· Every transaction affects two accounts or more

· At least one account will be debited and at least one account will be credited

· The total of the amount(s) entered as debits must equal the total of the amount(s) entered as credits

· When cash is received, debit Cash

· When cash is paid out, credit Cash

· To increase an asset, debit the asset account

· To increase a liability, credit the liability account

· To increase owner's equity, credit an owner's equity account

· To increase revenues, credit the revenues account

· A credit to a revenue account also causes an increase in owner's equity

· To increase expenses, debit the expense account

· A debit to an expense account also causes a decrease in owner's equity.

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