Accounting / Bookkeeping Basics: Debits And Credits

Debits And Credits
If you’re like most people, you probably think of the words “debit” and “credit” in terms of the kind of card you use to pay for items when you go shopping. When you use your debit card, the money comes directly out of your checking account; but when you use your credit card, instead of money being deducted from your bank account, the amount of the purchase is added to the total bill you will pay your credit card company at the end of the month.
This is a very basic understanding of debits and credits can help you navigate the terminology of this part of recording financial transactions for your business. However, in the world of bookkeeping, this essential concept is somewhat more complex.
First, before we explore the specifics of how debits and credits are used to record transactions in bookkeeping, let’s consider the basic equation upon which all accounting is based:
Assets = Liabilities + Equity

Whenever you see a mathematical equation, you know that the two elements on either side of the equals sign must have the same numeric value, so the following two equations are correct:
2 + 1 + 1 = 4
3 + 1 = 4
But this equation is incorrect:
2 + 3 = 4
Because the value of a business is calculated using the accounting equation, Assets = Liabilities + Equity, the numeric values of these  terms must be a balanced equation. If they are not, then your business’s books are out of balance, and in order to create accurate financial statements, you will have to locate where you have made bookkeeping errors.

Next, before we examine debits and credits in detail, we should take a moment to understand the terms in the accounting equation.
-     Assets are any resources that your company owns that represent a future value and can be expressed in monetary value. Cash is one type of asset, but there are many others. For example, investments, inventory, real estate, office supplies, equipment, and accounts receivable, all represent resources that you own and that can be assigned a monetary value. In addition, so-called “intangible assets” include your company’s reputation, your client base, the perceived value of your brand, etc.
-     Liabilities are the amount of outstanding financial obligations owed by your company.  So, your company’s liabilities may include the remaining balance on any mortgages, equipment leases, or business loans; accounts payable; or amounts received for future sales that have not yet been delivered.
-     Equity is the amount of financial interest all of a company’s shareholders have in the company. For example, if you buy 1,000 shares of stock in a new startup company at $2.25 per share, you can personally claim $2,250.00 of that company’s value as yours.
So, the accounting equation, Assets = Liabilities + Equity, means that in order for your company’s books to be considered balanced and in order, you must be able to show that the total value of all of your assets is exactly equal to the total value of all your liabilities plus the total value of all of the equity all shareholders may have in your company.
This seems like a daunting task, and that’s why accounting uses both debits and credits to record transactions.

Importance Of Debit And Credit Accounting
We began this chapter by considering a common understanding of debits and credits – using your debit card takes money out of your checking account; using a credit card adds money to your credit card bill. This is a great start to understanding the importance of using debits and credits to keep accurate books, but in terms of bookkeeping, this concept is more complex.

First, consider the definition of assets above. There are many types of assets, ranging from the balance in your business’s main checking account, to the total value of your inventory, to the value of your supplies and equipment, to the value of all the sales you have made for which you are awaiting payment. As a result, an accurate bookkeeping system will need more than just one account to track assets.
Next, you may also have many types of liabilities, including accounts payable and future sales, so you may have more than one account to record all your liabilities.
Finally, in addition to assets, liabilities, and equity, your bookkeeping system will have to keep track of revenue, expenses, gains, and losses.
Taken together, these categories of financial accounts – assets, liabilities, equity, revenue, expenses, gains, and losses – comprise what accountants call the chart of accounts and depending on the size and complexity of your company, the chart of accounts can become fairly complicated.
One more step, and the importance of debits and credits will become clear. Returning to the original example of shopping at your local department store, consider what happens when you buy something with your debit card – the amount of money in your checking account is reduced, but the amount of money in the department store’s checking account is increased. In addition, although you have less cash after making the purchase with the debit card, you have increased the value of your assets by the value of the term you purchased; and in return, the value of the store’s inventory has decreased by the value of the time they sold. The difference in making the purchase with a credit card is that instead of decreasing the amount of money in your checking account, you increase the amount of money you owe; similarly, the store does not receive an increase in the amount of money in their checking account, but they do see an increase in the value of their accounts receivable.
Thus, the concept behind debits and credits is that every single transaction has two parts – money is taken from one account, and money is added to another account. Because a company’s books account for a potentially complex chart of accounts, a system of debits and credits allows the bookkeeper to record all transactions accurately and consistently.

Recording Debit And Credit In An Account

First, remember that in accounting, debit is abbreviated dr. and credit is abbreviated cr. Second, although it is common to associate debit with deducting money and credit with adding money, debits and credits in bookkeeping are used differently. Depending on which type of transaction the company engages in and which type of account is affected, debits and credits may either increase or decrease the value of any given account. Specifically:
-     For asset accounts (e.g., your company’s checking account):
○     A debit will increase the value of the account; a credit will decrease the value of the account.
-     For liability accounts (e.g., your accounts payable account):
○     A debit will decrease the value of the account; a credit will increase the value of the account.
-     For equity accounts (e.g., the shares an investor holds in your company):
○     A debit will decrease the value of the account; a credit will increase the value of the account.

This seems to be the reverse order of the way you may normally think of debits and credits because it is based on the accounting equation, Assets = Liabilities + Equity. Thus, you cannot increase your assets unless you also increase your liabilities or equity. As a result, debits and credits within a bookkeeping system function differently than in a simple check register.
Of course, in some cases, recording a balanced transaction may require increasing the value of one asset account while decreasing the value of another asset account (instead of a liability or equity account). In these cases, there are additional rules that govern the function of debits and credits:
-     For revenue accounts:
○     A debit decreases the balance and a credit increases the balance.
-     For expense accounts:
○     A debit will increase the balance and a credit will decrease the balance.
-     For gain accounts:
○     A debit decreases the balance and a credit increases the balance.
-     For loss accounts:
○     A debit will increase the balance and a credit will decrease the balance.
Regardless, in terms of an actual book of accounts, debits are transaction values that are entered on the left side of an account, and credits are transaction values that are entered on the right side of an account.
Third, for every single transaction in bookkeeping, the total amount recorded as a debit must be offset by the exact same amount recorded as credit. If the two sides of the transaction are unequal, the books will not balance, and the bookkeeping system will not accept the entry.
Let’s look at some specific examples to clarify the concepts above.
For the first example, let’s assume your company sells computer accessories. One of your customers purchases a video camera attachment for a laptop computer at a cost of $375.00. The sale results in an increase in the value of your cash account. It also means that you have increased your revenue by converting inventory into cash. To record this transaction using debits and credits, the bookkeeper will use two accounts: cash and revenue.

When you sold the camera attachment to the customer, you  received $375.00 in cash, so the cash account is debited for 375.

To record the associated increase in revenue, the bookkeeper credits the revenue account for the same amount – 375.

Alternatively, the records may be displayed as follows:

Cash
Debits	Credits
375

Revenue
Debits	Credits
	375

In the next example, let’s assume that your company needs 10 new servers, and each server costs $1,000. You don’t want to use your cash account to make this purchase, so you instruct your purchasing agent to buy them on credit. The purchase results in an increase to the value of your fixed assets account. Because they were purchased on credit, there will be an equal increase to the value of your accounts payable. Here is how the bookkeeper will record the transaction:

Again, the same relationship can be displayed as follows:

Fixed Assets
Debits	Credits
375

Accounts Payable
Debits	Credits
	375

Finally, here are some additional guidelines to help get you oriented to the world of debits and credits:

Debit-Credit Table

Debit-Credit Acronyms
The following kinds of accounts (DEAL) are increased with a debit:
-     Dividends
-     Expenses
-     Assets
-     Losses

The following kinds of accounts (GIRLS) are increased with a credit:
-     Gains
-     Income
-     Revenues
-     Liabilities
-     Stockholders’ Equity

Debit-Credit Rules
Recording a debit means:
-     Increasing the value of an asset account
-     Increasing the value of an expense account
-     Decreasing the value of a liability account
-     Decreasing the value of an equity account
-     Decreasing the value of revenue
-     Debits are always recorded on the left

Recording a credit means:
-     Decreasing the value of an asset account
-     Decreasing the value of an expense account
-     Increasing the value of a liability account
-     Increasing the value of an equity account

-     Increasing the value of revenue
-     Credit are always recorded on the right

Main points about Debit & Credit
Double-entry accounting is generally used by businesses because entries always affect at least two different accounts. For example, when a company buys supplies, it affects the cash account and the supplies account or the accounts payable account and the supplies account, depending on if they are paying for the supplies now or in the future.
The double-entry system works using debits and credits. Debits are listed on the left side of the account and credits are listed on the right. Debits increase assets or decrease liabilities, while credits decrease assets or increase liabilities.
It can be tricky to remember which accounts are credited and which are debited. However, there are a few acronyms you can use to remember this information.
Debits increase DEAL accounts, or Dividends, Expenses, Assets, and Losses. These accounts are also decreased by credits.
Credits increase GIRLS accounts or Gains, Income, Revenues, Liabilities, and Stockholders’ (Owner’s) Equity. These accounts are also decreased by debits.