Debits and Credits

For Every Debit There Is A Credit

OR

Debits = Credits

This rule is the basis for the double entry bookkeeping system. If you recall, the double entry system is an accounting system that requires at least two entries to record a financial transaction.

What enables the double entry accounting system to work ? In two words Debits and Credits.

We learned in Lesson 2 that the double entry system based on the Accounting Equation allows us to track:

We've already discussed transactions and how they increase or decrease the assets, liabilities, and owner's equity of a business and their effects on the Accounting Equation in Lesson 2. All we're going to do now is give these increases and decreases an official bookkeeping name and definition. Can you guess the names of the terms that we're going to associate with increases and decreases ? I hope you said debit and credit.

Definitions of Debits and Credits

Debit (Left)

An entry in the financial books of a firm that increases an asset, draw, or an expense or an entry that decreases a liability, owner's equity (capital) or income.

Also, an entry entered on the left side (column) of a journal or general ledger account.

Let's combine the two above definitions into one complete definition.

An entry (amount) entered on the left side (column) of a journal or general ledger account that increases an asset, draw or an expense or an entry that decreases a liability, owner's equity (capital) or revenue.

Credit (Right)

An entry in the financial books of a firm that increases a liability, owner's equity (capital) or revenue, or an entry that decreases an asset, draw, or an expense.

Also, an entry entered on the right side (column) of a journal or general ledger account.

Let's combine the two above definitions into one complete definition.

An entry (amount) entered on the right side (column) of a journal or general ledger account that increases a liability, owner's equity (capital) or revenue, or an entry that decreases an asset, draw, or an expense.

Many accounting text books discuss debits and credits by concentrating on the simplistic definition of debits and credits. Debit means left, credit means right. In other words, a debit is a number written on the left side of an account and a credit is a number written on the right side of an account. While this is true, it only tells us on what side of an account we should place an entry. We also need to know when is an entry a debit (entered on the left side) and when is an entry a credit (entered on the right side) and how the entry affects the account.

This is where the key terms increase and decrease and the type of account (asset, liability, owner's equity, revenue, and expense) come into play. The term debit does not mean increase or decrease, nor does the term credit mean increase or decrease until the term is also associated with a type of account. In other words, debit does not always mean an increase nor does credit always mean a decrease , or vice versa. Also, the terms debit and credit do not refer to something good or bad.

In my opinion, good usable definitions of the terms debit and credit contain all three of the elements we just discussed:

Left Side / Right Side

Increase / Decrease

Associated Type Of Account

Can you guess what definitions I prefer to use for debit and credit from the three definitions that I presented earlier ? The ones that contains all three elements.

Debit

An entry (amount) entered on the left side (column) of a journal or general ledger account that increases an asset, draw or an expense or an entry that decreases a liability, owner's equity (capital) or revenue.

Credit

An entry (amount) entered on the right side (column) of a journal or general ledger account that increases a liability, owner's equity (capital) or revenue, or an entry that decreases an asset, draw, or an expense.

These versions of the accounting equation simply state that assets, also called property, equals what is owed to creditors (liabilities) and the owners (owner's equity), these two elements are also called property rights.

How do Debits and Credits relate to our Accounting Equations ? They're the tools used to keep our equations balanced.

The Balance of the Left Side of the Equation (Asset Accounts) will normally have a DEBIT Balance and the Balance of the Right Side (Liability and Permanent Equity Accounts) will normally have a CREDIT Balance.

Notice in our table that a debit increases the balances on the left side of the accounting equation (assets) and has the opposite effect and decreases the balances on the right side of the equation (liabilities and owner's equity). Likewise, a credit decreases the balances on the left side of the accounting equation (assets) and has the opposite effect and increases the balances on the right side of the accounting equation (liabilities and owner's equity).

Generally, anything that increases the left side of the equation (property or assets) or decreases the right side of the equation (property rights or liabilities and equity) is considered a debit and anything that increases the right side of the equation (property rights or liabilities and equity) or decreases the left side of the equation (property or assets) is considered a credit.

What we're doing here is relating the types of accounts (assets, liabilities, owner's equity, revenue, expense, and draws) and the terms increases and decreases to the terms debits and credits. The terms debit and credit by themselves do not mean an increase or a decrease. The terms have to be associated with the types of accounts in order to gain their meaning.

In other words, whether a debit or credit is an increase or decrease depends on the type of account.

Before we continue our discussion of debits and credits, let's take a look at how the terms are used with the major types of accounts. First we'll discuss assets, liabilities and owner's equity and then revenue, expense, and draws.

They say a picture's worth a thousand words ! Let's revisit our Expanded Accounting Equation Types of Transactions Table used in Lesson 2 and modify it slightly to include our new terms debit and credit. Our following new table illustrates the types of transactions that can occur and the effects of debits and credits on our expanded accounting equation.

Types Of Transactions Table using the Expanded Accounting Equation

The four basic types of transactions and their effects on our expanded accounting equation are represented by the letters a. b. c. and d.

Take note, this small table illustrates that each transaction is recorded by using a debit and a credit:

Transaction Type (a) Increases an Asset Account on the Left Side using a Debit and Increases a Liability or Owner's Equity Account on the Right Side using a Credit.

Transaction Type (b) Decreases an Asset Account on the Left Side using a Credit and Decreases a Liability or Owner's Equity Account on the Right Side using a Debit.

Transaction Type (c) Increases an Asset Account on the Left Side using a Debit and also Decreases an Asset Account on the Left Side using a Credit.

Transaction Type (d) Increases a Liability or Owner's Equity Account on the Right Side using a Credit and also Decreases a Liability or Owner's Equity Account on the Right Side using a Debit.

The result of this debit and credit "scheme" is that the accounting equation will always be in balance.

Transaction Analysis Using The Simple (Abbreviated) and Expanded Accounting Equations and Debits and Credits

Let's also revisit the tables from Lesson 2 where we analyzed the effects of business transactions on the accounting equation. In that lesson we had a table analyzing transactions using the simple or abbreviated accounting equation and another table that used the expanded accounting equation. This table presents both accounting equations in one table and adds our terms debit and credit to illustrate the effect of debits and credits on our accounting equations.

Let's see if you've been fibbing to me about those debits and credits.

By golly those debits and credits do equal each other.

Let's not forget "Ma Capital's (Owner's Equity) Kids" ! We also borrowed another table from Lesson 2 and included the terms debit and credit in the table.

Equity Table

Analysis of the Effects of Debits and Credits and Revenue, Expense, and Draws on Owner's Equity

In the previous table, we entered all the transactions that affected Owner's Equity under one heading; namely, Owner's Equity and disregarded whether it was a revenue, expense, or draw item. The following table illustrates where the transactions affecting Owner's Equity would actually be entered.

Instead of recording transactions directly to Owner's Equity ("Ma Capital"), proper bookkeeping actually uses her "Kids" Revenue, Expense, and Draws to record the increases and decreases to "Ma Capital" (Owner's Equity) in order to provide us with the answers to the how and why the owner's claim to the business's property increased or decreased.

This table also illustrates the effects of debits and credits on "Ma Capital's Kids" Revenue, Expense, and Draw. Of course only the sample transactions that affect Owner's Equity (Revenue, Expense, and Draws) have been included.

1. How different types of business transactions affect the Accounting Equation.
2. How it associates increases and decreases and the types of accounts with the terms debits and credit.
3. How each transaction was recorded twice illustrating double entry bookkeeping.
4. The total amounts for the tables prove the self-balancing nature of the Accounting Equation.
5. How transactions may require increases to both sides of the equation (increase left side using a debit and increase right side using a credit), decreases to both sides of the equation (decrease left side using a credit and decrease right side using a debit), or an increase and decreases on the same side of the equation (increase and decrease the left side or increase and decrease the right side of the equation using a debit and a credit), but the equation must always balance.
6. The Equity Table illustrates that, while transactions that affect Owner's Equity could be entered using only one column, additional useful information is obtained by breaking Owner's Equity into its component parts (kids) using the revenue, expense, and draws categories to record the transactions.
   1. That revenues increase owner's equity while expenses and draws decrease owner's equity.
   2. It illustrates that we could use only the Main Account Types - Assets, Liabilities, and Owner's Equity (Capital) contained in our Basic Expanded Accounting Equation (Assets = Liabilities + Owner's Equity) to record our transactions and not use "Ma Capital's Kids" Revenue, Expense, and Draws.
      1. The drawback of just using "Ma Capital" (the Owner's Equity Account) is that the Owner's Equity (Capital) Account would require a great deal of analysis and time in order to determine the income or loss for a period and the reasons for this income or loss.

From here on out, transactions will be recorded using "Ma's Kids" revenue, expense, and draws.

Can you guess what we're going to discuss next ? How about the Fully Expanded Version of our Accounting Equation and debits and credits.

Fully Expanded Version of The Accounting Equation and Debits and Credits

In Lesson 2, we discussed, developed, and explained the Fully Expanded Accounting Equation. I also said that we would be revisiting this topic in this lesson. Well, I'm a man of my word.

If you recall,

since

(1) Property = Assets and

(2) Property Rights (Claims to the Property) = Liabilities + Equity,

the simple or abbreviated accounting equation Property = Property Rights expanded or restated became

Assets = Liabilities + Owner's Equity.

We also concentrated on the Owner's Equity (Capital) portion of the equation and discussed how the balance of Owner's Equity ("Ma Capital") is affected by her "kids" Revenue, Expense, Investment, and Draws.

• Let's review these effects one more time:
• Owner Investments (Kid Investment) increase Owner's Equity
• Revenues (Kid Revenue) increase Owner's Equity
• Expenses (Kid Expense) decrease Owner's Equity
• Owner's Draws (Kid Draws) decrease Owner's Equity

Using the above information we arrived at the following equation:

Current Owner's Equity = Beginning Owner's Equity + Owner's Investments + Revenues - Expenses - Draws

Our new owner's equity equation illustrated the relationships and effects investments, revenue, expense, and draws have on Owner's Equity.

Taking this one step further, we arrived at our Fully Expanded Accounting Equation which included all the components that make up and affect Owner's Equity.

Our Expanded Accounting Equation Assets = Liabilities + Owner's Equity expanded or restated became our

Fully Expanded Accounting Equation

Assets = Liabilities + Beginning Owner's Equity + Additional Owner Investments + Revenues - Expenses - Draws.

In the Expanded Version of the Accounting Equation, "Ma Capital's Kids" are hiding behind her skirt. They're there; you just don't see them. The fully expanded version unhides them and shows you their affects on Owner's Equity ("Ma Capital").

• Assets = Liabilities + Ending Owner's Equity
• Revenues - Expenses = Profit or Loss
• Beginning Owner's Equity + Owner's Contributions + Revenue - Expense - Draws = Ending Owner's Equity
• Asset Accounts normally have Debit Balances.
• Liability Accounts normally have Credit Balances.
• Owner's Equity ( Capital ) Account normally has a Credit Balance.
• Two of Ma's Kids, Expense and Draws, normally have a Debit Balance.
• Two of Ma's Kids, Revenue and Investments normally have a Credit Balance.
• Revenues increase Owner's Equity ( Capital ) because they're added to Owner's Equity.
• Expenses decrease Owner's Equity ( Capital ) because they're subtracted from Owner's Equity.
• Draws decrease Owner's Equity ( Capital ) because they're subtracted from Owner's Equity.
• Besides the Owner's Original Investment in his/her business, at times, the owner may have to contribute or invest additional assets which increase Owner's Equity.
  • Note: Additional owner investments are normally added directly (credited) to the Owner's Capital Account Balance.
• Owner Draws are not used to figure the profit or loss of the business.
  • Note: The owner's draws could be equal, less than, or more than the profit / loss of the business.
• Additional Owner Contributions, Revenues, Expenses, and Draws eventually are all merged together and become a part of the Ending Owner's Equity Balance. If you've heard the phrase Closing The Books, believe it or not, this is all that's basically involved in Closing The Books.

Account Definition

An Account is a separate record for each type of asset, liability, equity, revenue, and expense used to show the beginning balance and to record the increases and decreases for a period and the resulting ending balance at the end of a period.

You should be aware that All Accounts:

Can Be Debited and Credited

Have an Increase Side (Column) and a Decrease Side (Column)

Have a Debit Side (Column) and a Credit Side (Column)

Debit Side is the Left Side (Left Column)

Credit Side is the Right Side (Right Column)

Have a Type and are classified as an Asset, Liability, Equity, Revenue, Expense, or Draw

Are Either a Balance Sheet or Income Statement Account

Have a Normal Balance Amount that is normally a Debit Balance or a Credit Balance

The Normal Balance is the debit or credit balance that an account is expected to have.

The normal balance is also the side of the account that increases the balance of the account. Since the increase side of assets, draws, and expense accounts is the left (debit) side these accounts normally have a debit balance. Likewise, since the increase side of liabilities, revenue, and owner's equity (capital) accounts is the right (credit) side these accounts normally have a credit balance. In other words, since debits increase asset, draw, and expense accounts, they normally have a debit (left side balance). Conversely, because credits increase liability, equity, and revenue accounts, they normally have a credit (right side) balance.

Comment:An account can occasionally end up with a balance that is not its normal balance. A good example would be a business "strapped" for cash that ends up with a credit balance in its cash account by writing out checks for more funds than they have on deposit in the bank. This credit balance signifies that the account is overdrawn, and instead of being classified as an asset, which it normally is, is now a temporary liability (amount owed to bank).

Do you remember this Equation ?

I mentioned this equation at the end of Lesson 2 ? The Debit and Credit Equation is just a variation (rearranged version) of the Fully Expanded Accounting Equation. Some simple Algebra was used to rearrange the major types of accounts.

Debit and Credit Equation

Assets + Draws + Expenses = Liabilities + Owner's Equity + Revenue

Normal Debit Balance Accounts = Normal Credit Balance Accounts

In this rearranged form of our fully expanded accounting equation, all the types of accounts that have a normal debit balance are listed on the left side of the equal sign and all the types of accounts that have a normal credit balance are listed on the right side of the equal sign.

Based on our Debit and Credit Equation we can state the following:

Normal Account Balance

Debit Balances

Asset - Normally a Debit Balance

Draws - Normally a Debit Balance

Expense - Normally a Debit Balance

Credit Balances

Liabilities - Normally a Credit Balance

Owner's Equity ( Capital ) - Normally a Credit Balance

Revenue - Normally a Credit Balance

Just knowing the normal balances for the types of accounts makes it much easier to determine when to use debits and credits. Now, let's dig in and learn some rules or methods.

Methods for Determining What To Debit and Credit.

While they all require some degree of memorization, some are less taxing on the brain cells than others.

(1) Memorize the definitions for debits and credits.

Debit - An entry (amount) entered on the left side (column) of a journal or general ledger account that increases an asset, draw or an expense or an entry that decreases a liability, owner's equity (capital) or revenue.

Credit - An entry (amount) entered on the right side (column) of a journal or general ledger account that increases a liability, owner's equity (capital) or revenue, or an entry that decreases an asset, draw, or an expense.

This is actually no different than memorizing the other terms that were presented in Lesson 1.

(2) Convert the Definitions To Detail Debit and Credit Rules and Memorize The Rules

At least I've supplied a Table and a T-Account presentation of the Accounts to help in this endeavor.

Our Summarized Debit and Credit Rules Table

A debit increases an asset while a credit decreases an asset.

A debit decreases a liability while a credit increases a liability.

A debit decreases owner's equity while a credit increases owner's equity.

A debit decreases revenue while a credit increases revenue.

A debit increases an expense while a credit decreases an expense.

A debit increases a draw while a credit decreases a draw.

If you look at the expense and draw categories, there appears to be a contradiction. In the Equity Table presented earlier in this lesson, the description for a debit to an expense says it decreases equity which is exactly what an expense does. It reduces the owner's claim to the property (assets). What might be a "little" confusing is that our summary of how debits and credits affect categories says that a debit to an expense is an increase. This is also true. The debit increases the amount of the expense which in turn decreases owner's equity.

Let's clarify with a simple example. Assume my business has advertising expenses of $2,000.00 as of yesterday. I write a check today for a another $1,000.00 for advertising. I debit advertising for $1000.00 which increases the amount spent on advertising to a total of $3,000.00 and has the additional effect of decreasing my equity by an additional $1,000.00.

The same logic applies to draws.

Our Rules Illustrated With T-Accounts

What the heck is this ? T-Accounts are used as a tool to illustrate business transactions, debits and credits, double entry bookkeeping, and the purpose of accounts. It is called this because it has the form of the letter T. On the top of the horizontal bar there is the account title (name). Increases and Decreases are placed on the side of the vertical bar depending on whether the account type is an asset, liability or equity account. The left side of the T-account is called Debit, and the right side is called Credit. These terms are often abbreviated as Dr. and Cr.

We accountant types say an account has been debited when an amount is placed on the left side of an account and credited when the amount is placed on the right side. The difference between the debit and the credit side of an account (total increases less total decreases) is called the account balance.

(3) Simplify and Summarize the Detail Debit and Credit Rules

This develops rules based on our earlier discussion of normal account balances and our Debit and Credit Equation that was derived from our Fully Expanded Accounting Equation and was presented earlier.

Assets + Draws + Expenses = Liabilities + Owner's Equity + Revenue

Normal Debit Balance Accounts = Normal Credit Balance Accounts

Using this knowledge, we can state our simplified debit and credit rules as:

All Accounts that Normally Have a Debit Balance (Left Side of Our Debit and Credit Equation) are Increased with a Debit and Decreased with a Credit.

Assets

Draws

Expenses

All Accounts that Normally have a Credit Balance (Right Side of Our Debit and Credit Equation) are Increased with a Credit and Decreased with a Debit.

Liabilities

Owner's Equity ( Capital )

Revenue

(4) Simplify Even More

If you're anything like me, you like it as simple as possible. As others have done using acronyms, I've developed my own method for determining when to use debits and credits that builds on and simplifies the prior method.

Bean Counter's Simple Debit and Credit Rule

My method begins by identifying the major types of accounts which of course are Assets, Liabilities, Owner's Equity, Revenue, Expense, and Draws.

Next, we determine how many major types of accounts are listed. Our listing includes 6 (six).

Assuming that we wanted to group these 6 (six) accounts into 2 (two) equal groups, how many account types would be included in each group ? If my math is correct 6/2 (six divided by two) is equal to 3 (three).

Also assuming that we wanted to alphabetize our account groups, our listing would appear as Assets, Draws, Expenses, Liabilities, Owner's Equity, and Revenue.

Now, dividing this listing into our 2 (two) groups with three account types in each we have:

• Group 1
  • Assets, Draws, and Expenses
  • This group is the types of accounts that normally have a debit balance.
• Group 2
  • Liabilities, Owner's Equity, and Revenue
  • This group is the types of accounts that normally have a credit balance.

Now, let's just use the first letter of each group to represent the type of account.

• Group 1
  • A (Asset), D (Draw), and E (Expense)
• Group 2
  • L(liability), O (Owner's Equity), and R (Revenue)

Now we have our ingredients for Bean Counter's Simple Debit and Credit Rule.

All A, D, and E (Asset, Draw, and Expense) types of accounts, which normally have a debit balance, are increased with a debit and decreased with a credit.

All L,O, and R (Liability, Owner's Equity, and Revenue) type accounts, which normally have a credit balance, are increased with a credit and decreased with a debit.

All you have to remember is that:

1. Group 1 types of accounts (A, D, and E) all normally have a debit balance and their balances are increased by using a debit.
2. Group 2 types of accounts (L, O, and R) all normally have a credit balance and their balances are increased by using a credit.
3. Just use the other term (reverse) to record the decrease for each group.
   1. In other words, if a debit increases the balance of a type of account in the group, then a credit is going to decrease the balance of the type of account in the group. Likewise, if a credit increases the balance of a type of account in the group, then a debit is going to decrease the balance of the type of account in the group.

(5) When all else fails, there's my Debit Credit Cheat Sheet.

Who says you can't have a cheat sheet unless of course you're taking an exam ?

Additional Clarification:

Since Assets, Draw, and Expense Accounts normally have a Debit Balance, in order to Increase the Balance of an Asset, Draw, or Expense Account enter the amount in the Debit or Left Side Column and in order to Decrease the Balance enter the amount in the Credit or Right Side Column.

Likewise, since Liabilities, Owner's Equity (Capital), and Revenue Accounts normally have a Credit Balance in order to Increase the Balance of a Liability, Owner's Equity, or Revenue Account the amount would be entered in the Credit or Right Side Column and the amount would be entered in the Debit or Left Side column to Decrease the Account's Balance.

How To Use and Apply The Debit and Credit Rules:

(1) Determine the types of accounts the transactions affect-asset, liability, revenue, or expense account.

(2) Determine if the transaction increases or decreases the account's balance.

(3) Apply the debit and credit rules based on the types of accounts and whether the balance of the account will increase or decrease.

So you know !

There are various symbols that are used to indicate Debits and Credits and whether an account's balance is a Debit or a Credit.

• Ways and symbols you might run across are:
• Dr for Debit and Cr for Credit
• + (Plus Sign) for Debit and - (Minus Sign) for Credit
• No Bracket for Debit and < > (Brackets) for Credit
• No Parentheses for Debit and ( ) (Parentheses) for Credit

Note: The plus (+) and minus (sign) are often used by accounting and bookkeeping programs to indicate debits and credits. Don't get confused and think that the plus sign means an increase or that the minus sign means a decrease. They do not. In this case, they are simply symbols that mean either a debit or a credit.

You're all probably familiar with the saying "Can't See The Forest For The Trees". So, before we move on, let's step back out of the trees (detail) so we can see the forest (big picture) regarding debits and credits.

An Account has an Increase Side (Column) and a Decrease Side (Column).

The Left Side (Column) of an Account is the Debit Side (Column) and the Right Side (Column) of an Account is the Credit Side (Column).

Debits are simply entries in the left column of an account and Credits are simply entries in the right column of an account.

When you record an entry in the Left Side (Column) of an Account this is called Debiting an Account.

When you record an entry in the Right Side (Column) of an Account this is called Crediting an Account.

Debits do not always represent increases to an account's balance. Nor, do they always represent decreases to an account's balance.

Likewise, Credits do not always represent increases to an account's balance. Nor, do they always represent decreases to an account's balance.

Whether a Debit or Credit to an Account is an Increase or Decrease depends on the Type of Account - Asset - Liability - Owner's Equity - Revenue - Expense - Draw.

A credit to a particular type of account always does the opposite that a debit does. In other words - if a debit increases an account's balance a credit decreases the account's balance or vice versa - if a debit decreases an account's balance a credit increases the account's balance.

All Accounts have a Normal Balance which is either a Debit Balance or a Credit Balance.

Assets, Draws, and Expenses all have Normal Debit Balances.

Liabilities, Owner's Equity (Capital), and Revenue all have Normal Credit Balances.

When using the double entry bookkeeping system, the sum of the debits must equal the sum of the credits for a transaction to be in balance.

Every transaction must have a dollar entry entered on the left side of an account(s) and a dollar entry entered on the right side of an account(s).

When calculating an Account's Balance, Debits are always added together and Credits are always added together; but a Debit and Credit are subtracted from each other.

Just as you have a left and right side of the accounting equation, you also have a left and right side of an account.

Every transaction involves at least one debit and one equal offsetting credit. If a transaction has more than one debit and/or credit, the total of the debits must equal the total of the credits. This is called a compound entry.

The term Debit should not be associated with good or bad. Likewise the term Credit should not be associated with good or bad.

If we properly use debits and credits to record and summarize our bookkeeping records, our Debits will always equal our Credits and provide some assurance that our records are accurate.