Understanding debits and credits in accounting

Debits and credits are one of those fundamental concepts 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.

Accounting balance

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:

·       
Cash

·       
Accounts receivable

·       
Inventory

·       
Prepaid expenses

·       
Plants

·       
Equipment

·       
Buildings

·       
Land

·       
Office Supplies

·       
Investments

Liabilities include the
following:

·       
Accounts payable

·       
Notes payable

·       
Long-term debt

·       
Unearned fees

Owners’ Equity includes
the following:

·       
Invested capital

·       
Retained earnings

·       
Surplus


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 


1.     Decide which
accounts are affected by a transaction.

2.     Decide whether
those accounts are debit accounts or credit accounts.

3.     Decide if the
accounts are increasing or decreasing.

4.     Debit or credit the
accounts as instructed above. 

Examples

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