Debits and credits are the two entries that capture all the dollars that pass through a business. Lose any one, and your books cease to balance, no exceptions, no shortcuts. Whether it is an invoice you send, a bill you pay or a dollar in the hands of a customer, all that touches at least one debit and one credit. This blog dissects how the two actually work, why banks appear to bend the rules, and how to make a journal entry the first time and be able to do it correctly with real numbers.
What Are Debits and Credits in Accounting?
Debit adds to some accounts and subtracts from others. A credit is a credit. That one rule, used in the same manner every time, makes the books of a company balanced regardless of the size of the business.
This is the very system that accountants have been using since 1494, when Italian mathematician Luca Pacioli published Summa de Arithmetica and first wrote about double-entry bookkeeping. However, the reasoning remains the same over 500 years later: any transaction requires two counterparts, and a counterpart always equals. Even today with most of the manual processes being automated by modern accounting software, it runs on the same basis.
It all comes together in the accounting equation: Assets = Liabilities + Equity. Each debit and credit entry maintains this equation in balance, transaction after transaction, as many debit and credit transactions as a business conducts, five a month or five thousand.
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What Do Debit Accounts and Credit Accounts Mean?
A debit account is increased by a debit entry and decreased by a credit entry. A credit account operates oppositely as a credit makes it go up, so a debit makes it go down.
Five types of accounts are usually sufficient to maintain books of most small businesses: assets, liabilities, equity, revenue, and expenses. Higher-order enterprises will tend to include extra two, gains and losses, to decouple income earned in normal operations from income earned or lost in one-off activities such as selling a piece of equipment at a higher price than it is recorded. Both assets and expenses, as well as losses, are debit accounts.
There are the liabilities, the equity, revenue and gains which act like credit accounts. Each transaction involves at least one pairing of debit accounts and credit accounts and knowledge of which type an account belongs to gives you immediate information as to whether an account belongs on a credit or debit side of the entry.
Why Does My Bank Statement Show Debit and Credit Backwards?
Since you see your bank looking at its books, not yours. To the bank, your checking account balance is not an asset but a liability or funds the bank owes you on demand.
When your bank credits your account, it is adding to what it owes you, and it is no different than any other liability account: credits add to liabilities. When your bank “debits” your account for a monthly fee, it’s decreasing that liability. Cash is an asset on your own books, and, therefore, the same transaction will be entered in the reverse manner: a deposit will debit your Cash account, and a fee will credit it. Nothing concerning the rule behind it. All that differs is what books you are reading, and that one difference clears up nearly all the moments of why this feels backwards. Beginners are about to hit.
What’s the Real Difference Between a Debit and a Credit?
The difference between real credit vs debit is a matter of direction, rather than value. Nor does each of them imply either good or bad on its own; a debit is not a loss, and a credit is not necessarily a gain.
An increase in a cash account is a debit which implies that more money was received. When a debit is taken to a loan payable account, the business paid down debt, a good financial action even though it is technically a debit. The label never matters; context does. That is the most backwards part that beginners get and that is precisely why memorizing rules by category of account works much better than memorizing debit bad, credit good.
What Are the Debit and Credit Rules for Each Account Type?
It is a system where each time you know the category you belong in, by which I mean none don’t fit and that are zero.
With a credit, assets, expenses and losses increase with a debit and vice versa. The opposite happens with liabilities, equity, revenue and gains, where a credit leads to an increase in the balance and a debit leads to a decrease in the balance. A simple memory device many bookkeepers rely on to commit this to memory is to remember the acronym DEAL of the accounts that increase with a debit: Dividends, Expenses, Assets and Losses. All that is beyond that group increases with a credit rather. This trend applies to all transactions that a business has ever made, whether it is a $12 office supply order or a six-figure equipment purchase.
How Do You Write a Journal Entry With Debit and Credit Entries?
Each journal entry must have at least one line of debit and one line of credit and the two sides must always have equal amounts. The key to recording debits and credits journal entries is to identify the accounts into which a transaction is going to touch, and apply account-type rules above to each account.
Consider a simple two-account situation: a company purchases some office supplies in cash, costing $500. Supplies are an asset, and it increases; therefore, the account is debited with $500. Another asset is cash, which reduces; therefore account is credited with $500. Each side is $500 and the entry balances immediately.
The rightness of journal entries in debit and credit placement is nothing more than getting the type of account correctly figured out first, attempting the entry without first getting the type of account correct and you will have the entry in backwards even when the dollar amount is correct. Some transactions hit more than two accounts simultaneously. A sale of $10,000 at 5.6% sales tax such as would require a debit of $10,560 in Accounts Receivable, a credit in Revenue of $10,000 and a credit in Sales Tax Payable of the remaining $560, three lines, one balanced entry and yet would be exactly equal on either side.
What Do Real Journal Entry Examples Look Like?
The pattern clicks faster than any written rule itself because you see several transactions side by side.
| Transaction | Account Debited | Account Credited |
| Business receives $2,000 cash from a customer | Cash | Revenue |
| Business pays $800 rent in cash | Rent Expense | Cash |
| Business takes out a $10,000 bank loan | Cash | Loans Payable |
| The owner invests $5,000 into the business | Cash | Owner’s Equity |
| Business pays off $1,500 of a loan | Loans Payable | Cash |
| Business sells $10,000 of product plus $560 sales tax | Accounts Receivable ($10,560) | Revenue ($10,000) + Sales Tax Payable ($560) |
Here you can see the trend in almost every row, that is, when money enters the bank, cash is increased with a debit and when money leaves the bank, the cash is reduced with a credit. A credit increases revenue, loans and equity. When this table clicks, the majority of the daily transactions no longer need a second thought.
What Is Double-Entry Bookkeeping?
Only transactions are recorded two times in bookkeeping, as a debit and a credit thus, the books remain balanced at any given time. In contrast, single-entry accounting only records one part of a transaction and provides much less protection against mistakes. Which is why it is principally used in very small operations that deal with cash-in and cash-out.
A two-way accounting system helps to highlight errors. When the total debits and total credits are never equal, something was entered incorrectly and the imbalance is immediately reflected and not months later in a nervous end-of-year reconciliation. All entries begin in the general journal and proceed through the process of posting to the general ledger, where they are used to revise the running balance of each separate account. The entire system can be summed up in seven words by a famous accounting adage: debit what comes in, credit what goes out.
Also Read: https://outsourcedaccountants.us/single-entry-bookkeeping-vs-double-entry-bookkeeping/
Debit and Credit Cheat Sheet by Account Type
Have this table handy the next time an account does not seem correct to you; it includes all the account categories that a small business utilizes.
| Account Type | Debit Effect | Credit Effect | Normal Balance |
| Assets | Increase | Decrease | Debit balance |
| Liabilities | Decrease | Increase | Credit balance |
| Equity | Decrease | Increase | Credit balance |
| Revenue | Decrease | Increase | Credit balance |
| Expenses | Increase | Decrease | Debit balance |
| Gains | Decrease | Increase | Credit balance |
| Losses | Increase | Decrease | Debit balance |
The column of normal balance informs you on which side you need an account to be when all things are properly recorded. An asset account with a credit balance, nearly always indicates something wrong to look into immediately. This type of shorthand should be on any bookkeeper’s desk, for accounting jargon is much easier to remember when it is associated with something seen rather than one memorized paragraph.
How Do Debit and Credit Entries Flow Into Financial Statements?
All the entries of credits and debits will ultimately be deposited on one of the two reports: the balance sheet or the income statement. The balance sheet is a flow of asset, liability and equity accounts and reflects the financial position of a company at one point in time. The revenue, expense, gain and loss accounts are then fed into the income statement that reflects the performance in a period of time- a month, a quarter or a complete year.
It is due to this fact that accuracy at the level of entry is of such importance. One misclassified transaction does not simply cause one account to be miscalculated but rather it alters the financial statement. This account feeds into and the miscalculated figure is the first one a lender, investor or the IRS looks at. Clean debits and credits at the origin will generate clean statements down the line; no additional effort is needed subsequently.
How Can Businesses Simplify Their Accounting Workflow?
Hours that most business owners do not have are spent manually tracking every debit and credit in dozens of monthly transactions. A clean accounting process relies on clean, accurate entries on the first day of the year. It will take a lot more time and money to find an error six months later than to find it on the first.
Sometimes, it takes more than a quick fix in businesses that lag with entries. Customized Bookkeeping Plans are available to play catch-up months of transactions that have not been posted and get all the accounts back to the proper balance before tax season comes around.
To be more accurate in the future, the bookkeeping of daily business activities will be done by the Outsourced Bookkeeping Services of the Outsourced Accountants and the business owners will no longer have to make assumptions about which side of an entry a transaction should be on.
Couple that with the Best Outsourced Accounting Services of elevated reporting and a business will have the right books and a transparent financial view but without the expense of employing a full in-house accounting team.
Frequently Asked Questions
What is the simple meaning of debit and credit?
Every accounting entry has two sides: debit and credit entries. Debit will add to assets and expenses; credit will add to liabilities, equity and revenue. No transaction can be made without the other and the two always add up to the same amount.
Is all debit a money reduction?
No. A debit makes cash and other asset accounts bigger. It reduces only accounts such as liabilities, equity and revenue. This effect is dependent upon the type of accounts, rather than the term debit.
What is the distinction between a debit balance and a credit balance?
A debit balance indicates that the normal running balance of the account is on the debit side of the account, which is the case with assets and expenses. A credit balance implies that the account is generally on the credit side, true of liabilities, equity and revenue.
Why then should debits and credits be equal?
Since the accounting equation, Assets = Liabilities + Equity, must always remain balanced. The debits and credits of each entry are equal to ensure that the total assets and total liabilities are always equal to the total equity.
Why does my bank say it’s crediting my account when I deposit money?
Since the bank will follow up on your checking account as its liability, and not your account. An increase in deposits makes the bank owe you more, and an increase in liabilities is a credit, although the same deposit is a debit on your own books.
How can one easily remember the rules of debit and credit?
A debit increases assets, expenses and losses. A credit increases the liabilities, equity, revenue and gains. Once learn those classes, and the right side of any record is a foregone conclusion.
Is it necessary that small businesses have double-entry bookkeeping?
Yes. Single-entry tracking lacks such errors as are automatically caught by double-entry, as the totals of debit and credit must always be equal. The default to the double-entry in most accounting software is precisely due to this reason even a straightforward business can use the in-built error check.
