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Understanding Debits and Credits in Accounting
The Importance of Debits and Credits
Debits and credits are one of those fundamental concepts in accounting. If you are having trouble understanding them, chances are you are going to be lost throughout the rest of accounting. Understanding debits and credits lays the foundation for almost anything else you do in accounting. If you confuse the two, your calculations will almost always be off.
Stop Thinking Like a Consumer
The typical person has heard the terms debit and credit tons of times in their lifetime. Usually the context of these terms includes the word card on the end. As a consumer, you typically think debit is good credit is bad. If you are going to grasp the concept of debits and credits, you will need to forget everything you think you know about them.
Where are They Recorded
Debit is often referred to as "dr" and means left. Debits are recorded on the left side of a balance sheet or ledger.
Credit can also be written as "cr" and means right. Credits are always recorded on the right side of a balance sheet or ledger.
Do not mistake these for being terms to mean an increase of decrease. The major difference between debits and credits is the side of the account they are recorded on.
For every debit or credit, there must be an equal account entry in the other column to balance it out. This represents the exchange that was made. You are showing with one account entry what was gained. The other account entry is showing what you sacrificed to obtain the other item.
Remember: The sum of debits must equal the sum of credits.
The left side of the balance sheet must equal the right side of the balance sheet. The left includes assets and expenses. The right side includes liabilities, owner's equity and revenue or profit.
The Basic Accounting Equation
Assets = Liabilities + Equity
Which Accounts are Which?
When you look at the basic accounting equation; you can see that assets are on the left and liabilities and equity are on the right. This tells use that assets are debit accounts and both liabilities and equity are credit accounts. We figure this out by which side of the equal sign the account is on in the equation.
Assets include the following:
- Accounts Receivable
- Prepaid Expenses
- Office Supplies
Liabilities include the following:
- Accounts Payable
- Notes Payable
- Long-term Debt
- Unearned Fees
Owners' Equity includes the following:
- Invested Capitol
- Retained Earnings
To Debit or Credit
Once you understand which accounts are debits or credits, you need to understand whether to debit the account or credit it. A general way to remember this is that increases in an account make the account more like what it already is. Decreases in an account make it less like what it already is. What is meant by this is:
- Increases in Debit accounts are debited.
- Increases in Credit accounts are credited.
- Decreases in Debit accounts are credited.
- Decreases in Credit accounts are debited.
Steps to Recording Transactions
- Decide which accounts are affected by a transaction.
- Decide whether those accounts are debit accounts or credit accounts.
- Decide if the accounts are increasing or decreasing.
- Debit or credit the accounts as instructed above.
A company buys $500 in land with cash.
- Cash is a Debit account. Since it is decreasing, we would credit this account by $500.
- Land is a Debit account. Since it is increasing, we would debit this account by $500.
- Debits = Credits
A company sells $1000 in products on credit.
- Sales is a Credit account. Since it is increasing, we would credit this account by $1000.
- Accounts Receivable is a Debit account. Since it is increasing, we would debit this account by $1000.
- Debits = Credits