Debits and credits are accounting entries that record business transactions in two or more accounts using the double-entry accounting system.
A very common misconception with debits and credits is thinking that they are “good” or “bad”. There is no good or bad when it comes to debits and credits. I’ve seen people say “oh, debits are good because they increase the assets accounts” but if you do that, you’re going to have a problem with expense accounts, which also have debit balances.
Put very simply, debits (dr.) always go in the left column of a t-account and credits (cr.) always go in the right column. That’s it. No exceptions.
- A debit is an entry on the left-hand side that increases an asset or expense account, or decreases a liability or equity account.
- A credit is an entry on the right-hand side that increases a liability or equity accounts, or decreases an asset or expense account.
Debits and credits are only used in the double-entry accounting system. For a single entry system, a single notation is made for the transaction and this is usually entered in a check box or a cash journal. It’s also worth knowing that a single entry system is only designed to produce one financial statement: the income statement.
Debit and Credit Accounts
We know that debits are amounts entered on the left-hand side of an account, and that credits are entered on the right-hand side. But what accounts do they affect, and how?
A common way that accountants often use to remember whether to credit or debit an account is using DC ADE LER.
That probably doesn’t make much sense on it’s own so let’s look at it in the context of a T-account:
So the DC stands for the headers, Debit and Credit. ADE in the left column refers to assets, draw (meaning money withdrawn from the business) and expenses. LER is liabilities, equity, and revenue.
Debit accounts on the left, credit accounts on the right. The movements between these accounts look like this:
- Debit will increase an asset
- Credit will increase a liability
- Debit will increase a draw
- Credit will increase an equity
- Debit will increase an expense
- Credit will increase a revenue
Debit and Credit Usage
As we’ve already covered, whenever you create a transaction, at least two accounts will be impacted using the double entry method. A debit entry recorded in one account, and a credit entry recorded in another.
It’s worth noting that there is no upper limit to the number of accounts involved in a transaction. As long as transaction balances, you can post entries across a number of accounts.
Another confusion with debit and credit accounts is something we covered briefly with DC ADE LER and it’s how debit and credits affect different accounts.
If you debit a cash account, this simply means the amount of cash increases. But if you debit an accounts payable account, it means your total amount of liability owing decreases.
Debits and credits have different impacts depending on the account types, and it all goes back to the basic accounting equation.
Here are the rules for debiting and crediting specific accounts:
- Asset accounts. A debit increases the balance and a credit decreases the balance.
- Liability accounts. A debit decreases the balance and a credit increases the balance.
- Equity accounts. A debit decreases the balance and a credit increases the balance.
- Revenue accounts. A debit decreases the balance and a credit increases the balance.
- Expense accounts. A debit increases the balance and a credit decreases the balance.
- Gain accounts. A debit decreases the balance and a credit increases the balance.
- Loss accounts. A debit increases the balance and a credit decreases the balance.
Debit and Credit Rules
The basic rules of debits and credits are:
- All accounts that usually have a debit balance will increase when a debit (left-hand side) is added, and decrease when a credit (right-hand side) is added. Debit accounts include assets, expenses and dividends (draw).
- All accounts that usually have a credit balance will increase when a credit (right-hand side) is added, and decrease when a debit (left-hand side) is added. Credit accounts include liabilities, equity and revenue.
- The debit side and credit side of a transaction must be equal. If not, the transaction is unbalanced and will result in an error in your accounting software that needs to be fixed.
Common Debit and Credit Transactions
As you spend more time working with the double-entry bookkeeping system, you’ll notice that there are some common business transactions that will crop up that you debit and credit regularly.
A few examples of these include:
- Sale for cash. Debit cash account | Credit revenue account
- Sale on credit. Debit accounts receivable account | Credit revenue account
- Cash payment for accounts receivable. Debit cash account | Credit accounts receivable account
- Purchase supplies with cash. Debit supplies expense account | Credit cash account
- Purchase supplies on credit. Debit supplies expense account | Credit accounts payable account
- Purchase inventory for cash. Debit inventory account | Credit cash account
- Purchase inventory on credit. Debit inventory account | Credit accounts payable account
- Pay employee salaries. Debit wages expense and payroll tax accounts | Credit cash account
- Take out a loan. Debit cash account | Credit loans payable account
- Repay a loan. Debit loans payable account | Credit cash account
Example of Debits and Credits
Let’s start a business together with $20,000 in cash.
To start, we need to purchase some materials to produce our product, which costs $500. Next, we need to sell those products, which we sell for a total of $800.
Finally, we decide that in order to grow, we need additional capital and we borrow $5,000 from the bank.
Here’s how the debits and credits might look for those transactions:
|Account Name||Debit (Dr.)||Credit (Cr.)|
|– Bank loan||5,000|
As you can see, there are two entries for each transaction and the total of the debits and credits for any transaction must always equal each other.
Most modern accounting software won’t even let you submit the entry if the debits and credits don’t balance.