What Are Debits and Credits?

Definition and Examples of Debits and Credits

Woman calculating debits and credits for a small business
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Debits and credits form the basis of the double-entry accounting system of a business. Debits represent money that is paid out of an account and credits represent money that is paid into an account. Each financial transaction made by a business firm must have at least one debit and credit recorded to the business's accounting ledger in equal, but opposite, amounts.

Bookkeepers and accountants use debits and credits to balance each recorded financial transaction for certain accounts on the company's balance sheet and income statement. Debits and credits, used in a double-entry accounting system, allow the business to more easily balance its books at the end of each time period.

What Are Debits and Credits?

Debits, abbreviated as Dr, are one side of a financial transaction that is recorded on the left-hand side of the accounting journal. Credits, abbreviated as Cr, are the other side of a financial transaction and they are recorded on the right-hand side of the accounting journal. There must be a minimum of one debit and one credit for each financial transaction, but there is no maximum number of debits and credits for each financial transaction.

The business's Chart of Accounts helps the firm's management determine which account is debited and which is credited for each financial transaction. There are five main accounts, at least two of which must be debited and credited in a financial transaction. Those accounts are the Asset, Liability, Shareholder's Equity, Revenue, and Expense accounts along with their sub-accounts.

A debit increases both the asset and expense accounts. The asset accounts are on the balance sheet and the expense accounts are on the income statement. A credit increases a revenue, liability, or equity account. The revenue account is on the income statement. The liability and equity accounts are on the balance sheet.

How Debits and Credits Work

When you pay a bill or make a purchase, one account decreases in value (value is withdrawn, which is a debit), and another account increases in value (value is received which is a credit). The table below can help you decide whether to debit or credit a certain type of account.

Table 1
  Increase Decrease
Assets Debit Credit
Liabilities Credit Debit
Shareholder's Equity Credit Debit
Revenue Credit Debit
Expenses Debit Credit
Chart of Accounts

Consider this example. A business receives its monthly electric utility bill in the amount of $550. You would debit, or increase, your utility expense account by $550, and credit, or increase, your accounts payable account by $550. Utility expense is a sub-account of the expense account on the income statement. Those are equal and opposite journal entries. The accounting entry you would make in your accounting journal would be the following:

Table 2
Date Account Name Debit Credit
May 1 Utility Expense $550  
    Accounts Payable   $550
       
Example of an Accounting Journal Entry Using a Debit and Credit

In an accounting journal, debits and credits will always be in adjacent columns on a page. Debits will be on the left, and credits on the right. Entries are recorded in the relevant column for the transaction being entered.

Determining whether a transaction is a debit or credit is the challenging part. This is where T-accounts become useful. T-accounts are used by accounting instructors to teach students how to record accounting transactions.

How Do You Record Debits and Credits?

For Journal Entries

Each T-account is simply each account written as the visual representation of a "T. " For that account, each transaction is recorded as debit or credit. This information can then be transferred to the accounting journal from the T-account. The T-accounts for the example of the electric utility payment in Table 2 would look like this:

Utility Expense (expense account)
Debit  Credit
Increases an expense account Decreases an expense account
Received $550 Paid 

A business owner can always refer to the Chart of Accounts to determine how to treat an expense account.

To complete this transaction, here is the T-account for the other side:

Accounts Payable (a liability account)
Debit Credit
Decreases a liability Increases a liability
Pays a bill Bill Due $550

Now you make the accounting journal entry illustrated in Table 2.

Asset Accounts

Assets consist of items owned by a company, such as inventory, accounts receivable, fixed assets like plant and equipment, and any other account under either current assets or fixed assets on the balance sheet.

Debits are increases in asset accounts, while credits are decreases in asset accounts. In an accounting journal, increases in assets are recorded as debits. Decreases in assets are recorded as credits. 

Here's an example. A company buys a large quantity of inventory to gear up for holiday sales. Inventory is a current asset, and the company pays for the inventory with cash. The company purchases $10,000 in inventory. The journal entry would look like this:

Example of an Accounting Journal Entry
Date Account Name Debit Credit
May 1 Inventory $10,000  
    Cash   $10,000
       
Asset Account

Inventory is an asset account. It has increased so it's debited and cash decreased so it is credited.

Here is a tip about how to handle the cash account:

When cash is received, the cash account is debited. When cash is paid out, the cash account is credited.

If the company decided to sell a building for $250,000 and it received cash for the property, the journal entry would look like this:

Example of an Accounting Journal Entry
Date Account Name Debit Credit
May 1 Cash $250,000  
     Fixed Assets   $250,000
       
Cash Account

Cash, an asset, increased so it would be debited. Fixed assets would be credited because they decreased.

Liability Accounts

Liabilities are what the company owes to other parties. They can be current liabilities, like accounts payable and accruals, or long-term liabilities, like bonds payable or mortgages payable.

Here's the rule for liability and equity accounts. Increases are debits and decreases are credits.

If a company has a bank loan and makes a $5,000 payment, here is an example of the journal entry:

Example of an Accounting Journal Entry
Date Account Name Debit Credit
May 1 Notes Payable $5,000  
     Cash   $5,000
       
Liability Account

You would debit notes payable because the company made a payment on the loan, so the account decreases. Cash is credited because cash is an asset account that decreased because cash was used to pay the bill. 

Owner's Equity Accounts

The owner's equity accounts are also on the right side of the balance sheet like the liability accounts. Examples are common stock and retained earnings. They are treated exactly the same as liability accounts when it comes to accounting journal entries.

Here is an example of a journal entry for the owner's equity account. A business has two owners and one owner wants to invest an additional $50,000 in the business. The common stock of the business is selling at its par value. Here's the resulting journal entry:

Example of an Accounting Journal Entry
Date Account Name Debit Credit
May 1 Cash $50,000  
     Common Stock   $50,000
       
Common Stock Account

According to Table 1, cash increases when the common stock of the business is purchased. Cash is an asset account, so an increase is a debit and an increase in the common stock account is a credit.

Expense Accounts

Expense accounts are items on an income statement that cannot be tied to the sale of an individual product. Of all the accounts in your chart of accounts, your list of expense accounts will likely be the longest.

Expense accounts run the gamut from advertising expenses to payroll taxes to office supplies. It's imperative that you learn how to record correct journal entries for them because you'll have so many.

Here's an example of a business transaction involving an expense account and the resulting journal transaction. A company purchases $750 in office supplies using cash. Here's the resulting journal entry:

Example of an Accounting Journal Entry
Date Account Name Debit Credit
May 1 Office Supplies Expense $750  
     Cash   $750
       
Office Supplies Expense Account

Office supplies is an expense account on the income statement, so you would debit it for $750. Cash is an asset account. You credit an asset account, in this case, cash, when you use it to purchase something.

Revenue or Income Accounts

Revenue accounts are on a company's income statement. A company's revenue usually includes income from both cash and credit sales.

A company can also have revenue from investments. Larger companies sometimes invest in other companies. Smaller firms invest excess cash in marketable securities which are short-term investments.

Here is a sample journal entry for a revenue transaction. A small business has $5,000 in cash sales on a given day. Here's how those sales, which are revenue for the firm, would be recorded:

Example of an Accounting Journal Entry
Date Account Name Debit Credit
May 1 Cash $5,000  
     Sales Revenue   $5,000
       
Cash Sales

Sales revenue is posted as a credit. Increases in revenue accounts are recorded as credits as indicated in Table 1. Cash, an asset account, is debited for the same amount. An asset account is debited when there is an increase.

These steps cover the basic rules for recording debits and credits for the five accounts that are part of the expanded accounting equation.

Key Takeaways

  • For each financial transaction made by a business firm that uses double-entry accounting, a debit and a credit must be recorded in equal, but opposite, amounts.
  • The Chart of Accounts established by the business helps the business owner determine what is a debit and what is a credit.
  • The best way to learn how to record debits and credits is to use T-accounts then turning them into accounting journal entries.
  • The information from the T-accounts is then transferred to make the accounting journal entry.

Article Sources

  1. Fresh Books Cloud Accounting. "What is a Debit and Credit?" Accessed August 5, 2020.

  2. Accounting Tools. "Debits and Credits." Accessed August 5, 2020.

  3. Fresh Books Cloud Accounting. "What is a Debit and a Credit?" Accessed August 5, 2020.