What Are Accounting Debits and Credits?

What Are Accounting Debits and Credits? | Accounting Smarts
Charles Hall

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Charles Hall

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March 1, 2021

Accounting debits and credits are terms used to describe the recording of an accounting transaction. Debits are the left side and credits are the right side of the entry.

Listening to a bookkeeper or an accountant for any length of time might expose you to words that are not familiar like debit or credit. To an accountant, debit cash or credit accounts payable is considered an instruction on how to handle a transaction.

Debits and Credits are the basics of accounting. Accounting debits and credits are terms used to describe the recording of an accounting transaction. Debits are the left side and credits are the right side of the entry.

This double-entry system is actually the accounting method used to ensure records are complete and accurate.

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How do debits and credits affect accounts?

In order to understand how debits and credits work, you first need to understand accounts.

Accounts are individual buckets, so to speak, used to keep track or categorize transactions. Transactions then affect the account balance by either increasing or decreasing the amount in the bucket. Debits and credits are what determine if an account increases or decreases.

Broad Accounts (5 types)

  • Assets
  • Liabilities
  • Equity
  • Revenue
  • Expense

Debits and credits affect each account type differently. The chart below will tell you whether a debit/credit increases or decreases the specific type of account.

Sub-Accounts

Broad accounts are further subdivided into sub-accounts. Below is a simplified example of sub-accounts.

Assets

  • Cash
  • Accounts Receivable
  • Fixed Assets
  • Inventory

Liabilities

  • Accounts payable
  • Interest payable
  • Notes payable

Equity

  • Capital Stock
  • Retained Earnings

Revenue

  • Sales

Expense

  • Cost of Goods Sold
  • Payroll
  • Rent
  • Utilities
  • Interest expense
  • Bank Fees

Each sub-account listed under the broad account is affected the same way as the broad account. Remember, accounting uses double entry thus each transaction will have a debit account and a credit account. To illustrate see the examples below.

Example #1: Making a Sale

The Bike Shop sales a new mountain bike for $500. The mountain bike cost the Bike Shop $250. The accounting debits and credits would look like this:

Cash $500

Sales $500

(this transaction records the $500 cash received from the customer and records a sale for $500. The asset account “cash” was increased by a debit, and the revenue account “sales” was increased by a credit. Notice the debits and the credits balance)

The other part to this transaction is:

Cost of Goods Sold $250

Inventory $250

(this transaction records the removal of the bike from inventory at the $250 cost, and records the cost of that bike into Cost of Goods sold. The expense account “cost of goods sold” was increased by a debit and the asset account “inventory” was reduced by a credit. Notice the debits and the credits balance.

Example #2: Paying a Bill

The Bike Shop pays their monthly electric bill of $75. The accounting debits and credits would look like this:

Utilities $75

Cash $75

(this transaction records the $75 cash payment to the utility company and records the expense of $75. The asset account “cash” was reduced by a credit, and the expense account “utilities” was increased by a debit. Notice the debits and the credits balance.)

Example #3: Recording a Loan

The Bike Shop receives a loan for $10,000 with a 5% annual interest rate, paid annually. The accounting debits and credits would look like this:

Cash $10,000

Notes Payable $10,000

(this transaction records the $10,000 cash received from the bank and records a corresponding note payable for $10,000. The asset account “cash” was increased by a debit, and the liability account “notes payable” was increased by a credit. Notice the debits and the credits balance)

The other part to this transaction is:

Interest Expense $500

Interest Payable $500

(this transaction records the 1st year annual interest of $500, and records the interest payable of $500. The expense account “interest expense” was increased by a debit and the liability account “interest payable” was increased by a credit. Notice the debits and the credits balance.

Misunderstanding about accounting debits and credits

The most common misunderstanding about debits and credits is the debits increase an account and credits decrease an account. This is far from the truth.

  • Debits increase asset and expense accounts.
  • Debits decrease liability, equity and revenue accounts
  • Credits increase liability, equity and revenue accounts
  • Credits decrease asset and expense accounts.

You can see that debits and credits both increase and decrease accounts. This makes complete sense given that all accounts need to go up or down.

Cash (asset account) increases when you sell products or services, but decreases when you pay bills or refund customers.

Sales (revenue account) increases when you sell products or services, but decreases when you refund customers.

Because both debits and credits increase and decrease accounts you will never find accountants or bookkeepers using plus (+) or (-) notations to describe an account. That would be misleading.

Track accounting debit and credits with accounting software

Understanding debits and credits is important as it helps business owners better understand their finances of their business. But understanding and making the entries are two different things.

Today, online accounting software makes the double entry system of accounting work more efficiently and accurately. And best of all you don’t have to make the entries. Just enter a transaction and the system will do the rest.

Here are a couple of the best online accounting software options to help you keep track of your accounting debits and credits.

  1. QuickBoos Online has been around for many years helping accountants and bookkeepers keep track of the numerous transactions all businesses encounter on a daily basis. Getting started is easy and the monthly cost is very affordable.
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  1. Xero is a relative newcomer to the online accounting world, but having built their platform as an online service first makes them a leader. You will find their monthly rates are absolutely affordable and even less than that of QuickBooks Online.
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Charles Hall

Charles Hall

Charles has spent 25 plus years in the world of accounting and business. His experience includes working as a CPA/Auditor international accounting firms. He has worked as a controller and as a COO for small to medium sized companies.

Learn more about Charles Hall