One of the first orders of business when maintaining the accounting records for your company is understanding the difference between debits and credits. This concept is the backbone of all bookkeeping and accounting practices, so it’s crucial that you’re fully aware of what these terms mean and how to apply them correctly.
The tricky aspect of learning these concepts is that they behave differently depending on the specific account you’re managing. Thus, you’ll need to memorize the rules for each to avoid making errors in your general ledger.
As you continue reading through this guide, we’ll provide you with an overview of account debits and credits, how they differ, their role in producing accurate financial records, and some helpful tips for remembering how they each work.
In accounting, what is a debit and credit? Before we dive into specific examples of each and see how they work together to keep the books balanced, let’s quickly define each of these terms.
In accounting terms, a debit (Dr) increases the account balance for assets and expenses and decreases the balance for a liability, revenue, or equity account.
When looking at the general ledger, debits are always written on the left side.
A credit (Cr) works opposite to a debit. It increases the balance for liability, revenue, and equity accounts while decreasing the balance for asset and expense accounts.
Additionally, credits are always written on the right side of the general ledger.
Credits and debits do not work alone. In the accounting world, every transaction results in a debit to one account and a credit to another (sometimes more than one). This is the basis for double-entry accounting, and is how accountants and bookkeepers are able to keep financial records and the accounting equation “balanced”. As a reminder, the accounting equation looks like the following:
Assets = Liabilities + Equity
For example, if a company buys a new piece of equipment in cash, the value of its asset account increases, and the cash account decreases. Or, if the company receives a customer payment for an outstanding invoice, its cash account will go up, while accounts receivable goes down.
Taken together, the debit and credit that correspond to a given transaction are entered as a journal entry in the general ledger. This is where all accounting data for a company during a given period is compiled and recorded.
Again, debits and credits behave differently depending on the type of account involved in the transaction.
Here’s an overview of how they impact the five main types of accounts:
To see how this works in practice, let’s run through a few examples. And, if you’d prefer to delegate the tedious task of updating your general ledger to an expert team, consider using outsourced bookkeeping services, like those offered by Bob’s Bookkeepers.
Let’s say on November 1, an online retailer purchases new inventory on credit. Since inventory is considered an asset, the company would record a debit to the account to increase its value. Purchases on credit are considered a liability that the company still owes, so there would be a credit to accounts payable of the same amount.
Here is what the corresponding journal entry for this transaction would like look:
As we mentioned above, the debit is recorded on the left-hand side of the ledger, and the credit is shown on the right side, representing their balanced relationship to one another.
In this case, both the debit and credit result in an increase to their respective accounts. The transaction led the inventory (asset) account to go up in value, and the balance on accounts payable (liability) also went up. However, the transaction is still balanced because it resulted in both a credit and a debit, owing to the opposite rules for asset and liability accounts.
Now let’s review an example where the transaction results in more than one debit or credit.
One common such example is running business payroll, which involves multiple accounts like expenses, liabilities, and cash. Total payroll expense for the month is $50,000, and the company accrues $5,000 in payroll taxes. Here’s what the corresponding journal entries would look like:
