Debit and Credit
Double entry bookkeeping system uses debit and credit entries to record transactions. They are nothing else but entries that increase or decrease account balances – addition and subtraction, that’s it. To understand them correctly, remember that debits are always listed first (on the left side) and credits are second (on the right side), in journal entries and accounts (“T accounts”), balance sheet, everywhere.
Debit Credit Chart
A common misconception is that debit entry increases the account balance and credit decreases it. It is true for some accounts, however not for all. A debit-credit chart shows which accounts are increased by debit entries and vice versa.
|Assets||Liabilities + Equity|
|To Increase (+)||Debit||Credit|
|To Decrease (-)||Credit||Debit|
To understand the debits and credits chart think of the basic accounting equation again. The left hand side(assets) is increased by debit entries and decreased by credit entries. The right hand side(liabilities and equity) is increased by credit entries and decreased by debit entries. This is true for all normal accounts.
For example, lets have a simple transaction where we borrow $20,000 from a bank. Let’s first think about it, we are getting $20,000 in cash, which means that we need to increase our cash assets account (left hand side) and we are borrowing this amount which means we have to pay it back later, so we need to increase our notes payable liability account (right hand side).
Assets + $20,000 = Liabilities + $20,000 + Stockholder’s Equity
Some people use mnemonics or other memorizing techniques to remember which accounts are increased/decreased by debit/credit entries. I prefer to use logic instead. This is way even if I forget which entry to use, I can always figure it out by using these simple steps.
So first of all, remember the basic accounting equation, then think how this equation is changed. Are you adding to the both sides or subtracting? If adding – debit assets and credit liabilities or stockholder’s equity, if subtracting then credit assets and debit liabilities or stockholder’s equity. Sometimes only one side is changed which means that entries are only applied to either assets or liabilities/stockholder’s equity.
Ok, debit and credit entries are easy with normal accounts but with temporary accounts they are easy as well! Though, here you have to remember what temporary accounts are – revenue, expense, withdrawals, dividends,. etc. These are the accounts that are not presented on the balance sheet, well sort of. They are closed and transferred to the retained earnings account at the end of the accounting year.
For example, let’s have a sale for $10,000. What does it mean? It means that we increase the cash assets account by $10,000 and increase the Sales account, but Sales account is not presented in this equation yet. This is why you have to remember that all temporary accounts are transferred to equity eventually. Sales/Revenues increase the equity balance, this sale made us $10,000 so we worth more now, and we already know that to increase the equity account we need to credit it.
Assets + $10, 000 = Liabilities + Stockholder’s Equity + $10,000
Next comes the Cost of Goods Sold account, which is an expense account and not presented in the equation as well. It decreases equity, we had to spend $6,000 to purchase the inventory, which means we need to debit it.
Assets + $10, 000 – $6,000 = Liabilities + Stockholder’s Equity + $10,000 – $6,000
|Oct. 24||Cost of Goods Sold||6,000|
So, with temporary accounts think what these transactions do with equity, do they increase or decrease it? If increase credit, otherwise debit it.