Debits and credits represent the left and right side of the account, respectively. There’s actually no complex definition behind these two pillars of double-entry bookkeeping—and saying that debits are inflows and credits are outflows is a common misconception and misapplication of the debit-credit theory.
When I was still studying college accounting, it took some time to understand how debits and credits really work, which is why I understand small business owners who find it hard to grasp this concept.
Key Takeaways:
- Simply put, a debit is the left side of an account, whereas a credit is the right side. Both may increase or decrease an account depending on the nature of the transaction.
- A normal balance is the side of the account where it naturally increases. For instance, debits naturally increase assets. Hence, it has a normal debit balance.
- A T-account is a visual way to show how transactions are recorded. Each account has two sides: debits on the left and credits on the right.
- Debits always come first in a journal entry; credits come second and are indented to distinguish them from debits.
Understanding Debits and Credits Using the T-account
The T-account is the visual representation of an account. And if you look at the accounting equation, you’ll see the T-account hiding in plain sight.
Accounting Equation | |
DEBITS | CREDITS |
Assets = | Liabilities + Equity |
This illustration summarizes the relationship of debits and credits with the major account groups in the balance sheet. It tells us that assets—the resources that the business owns—may come from two sources: liabilities and equity. Thus, increasing both liabilities and equity increases assets and vice versa.
With these rules in place, debits and credits—whether they represent increases or decreases in specific accounts—must always balance, just like the accounting equation. The illustration below features a T-account, which presents debits on the left and credits on the right, helping track and balance transactions effectively.
The T-account
In accounting, the rule is that debits and credits must be equal. Just like the scales, debits and credits must be balanced.
Concept of the Normal Balance
When talking about debits and credits in accounting, you’ll often hear the term “normal balance” because it is one of the basics of accounting; think of normal balance as the default setting of an account, indicating the side where it naturally increases.
For instance, just as some people are naturally right- or left-handed, each type of account has a “hand” it favors—either debit or credit. An asset account, for example, naturally favors debits, so all increases in any asset account are recorded on the debit side. In contrast, a liability account favors credits, and all increases happen on the credit side.
Here are the rules for normal balance.
Credits always increase liabilities, equity, and revenues.
Therefore, if you flip the rule, credits decrease assets and expenses, whereas debits decrease liabilities, equity, and revenues. The trick is to focus on memorizing the normal balances first. Once you have, you can simply reverse the rules to determine how debits or credits affect each account type, making them much easier to understand.
T-Account Example
I initially found it hard to understand debits and credits by looking at journal entries. They were easier to look at visually using the T-account. I’ll show you below how to visually plot transactions using the T-account, while following the equality rule of the accounting equation.
Here are sample transactions:
- I invested $10,000 to start a business.
- I purchased equipment worth $2,000, payable in 90 days.
Accounting Equation | ||
DEBITS | CREDITS | |
Assets | Liabilities | Equity |
$10,000 (a) | $10,000 (a) | |
$2,000 (b) | $2,000 (b) | |
$12,000 | $2,000 | $10,000 |
Take note of the credit side. We have $2,000 liabilities and $10,000 equity. If we add them, we arrive at $12,000, which is the same amount of assets that we have. In practice, we don’t do it this way—but I’m showing you this to help you grasp the concept before I introduce you to journal entries.
Keep Reading:
We can further expand the T-account by adding income and expenses. Since I know that income has a normal credit balance, I will place that under the credit side. The same goes for expenses that go under the debit side.
Let’s add more transactions in our example:
- I earned $3,000 from a customer.
- I paid wages worth $1,000.
Accounting Equation | ||||
DEBITS | CREDITS | |||
Assets | Expenses | Liabilities | Equity | Revenues |
$10,000 (a) | $10,000 (a) | |||
$2,000 (b) | $2,000 (b) | |||
$12,000 | $2,000 | $10,000 | ||
$3,000 (c) | $3,000 (c) | |||
($1,000) (d) | $1,000 (d) | |||
$14,000 | $1,000 | $2,000 | $10,000 | $3,000 |
Our total debits is $15,000 ($14,000 assets + $1,000 expenses), and our total credits is $15,000 as well ($2,000 liabilities + $10,000 equity + $3,000 revenues). This simple illustration shows the crux of the double-entry accounting system—every transaction must affect at least two accounts, with at least one debit and one credit.
As much as I want accounting to be this way, using the T-account approach is something that’s not used everyday in practice. It is good for analysis only but is not ideal for recordkeeping. In the next section, I’ll discuss where you can see debits and credits on a daily basis.
Debits and Credits in a Journal Entry
The clearest way to see debits and credits in action is by looking at journal entries. In this article, I won’t go over the different types of journal entries, but you can check my comprehensive guide about journal entries if you want to learn more.
Here’s an example of a journal entry for the sale of fixed asset as a loss:
Date | Account | Debit | Credit |
|---|---|---|---|
June 30 | Cash | 3,500 | |
Accumulated Depreciation | 12,000 | ||
Loss on sale of fixed asset | 1,300 | ||
Fixed Asset | 16,800 | ||
(To record the sale of a fixed asset for cash) | |||
16,800 | 16,800 |
When preparing a journal entry, you can include multiple entries under the debit or credit column—as long as the total debits equal the total credits. In the example above, there are three debit entries and one credit entry, with each column adding up to $16,800.
Debit and Credit Examples & Analysis
One of the most challenging aspects of accounting is analyzing transactions, which involves the careful process of determining the appropriate debits and credits. If you get this wrong, everything that follows will be wrong. However, I will teach you a way to effectively analyze transactions.
EXAMPLE 1: On March 1, ABC Company purchased $1,000 worth of supplies on account from EFG Company.
Let’s assume I am the accountant of ABC Company. Below, you’ll see how I analyzed the transaction in my head. I used deductive reasoning to break down only the most important key terms in the transaction.
ANALYSIS
Let me explain these key terms: purchased, supplies, and on account.
When I purchase something, it means exchanging resources for an asset. In this case, the asset is supplies, which a company owns and uses for operations. Since supplies are an asset, buying them increases the asset’s balance. To reflect this increase, I debit the account because assets have a normal debit balance.
Now, consider the term “on account.” In accounting, this means buying something without paying immediately, creating a debt. This debt is a liability. When I incur a liability, its balance increases. So, I credit the account because liabilities have a normal credit balance.
With that analysis, I can now write the journal entry in the books of ABC Company:
Date | Account | Debit | Credit |
|---|---|---|---|
March 1 | Supplies | 1,000 | |
Accounts payable | 1,000 | ||
(To record purchase of office supplies) |
EXAMPLE 2: On March 31, ABC Company paid the liability to EFG Company for supplies purchased on March 1.
ANALYSIS
The keywords here are paid and liability. When I pay, it means money is leaving the business. That’s an outflow, which causes the assets to decrease. Normally, I’d debit assets when they increase, but since paying reduces assets, I do the opposite. So, I credit the asset account to show the outflow.
When it comes to paying off a liability, it means the business is settling a debt and is no longer responsible for it. This reduces the liability, so I need to remove it from the books. The general rule is that credits increase liabilities, but since I’m decreasing the liability, I need to debit the liability account to reflect the reduction.
The journal entry should be:
Date | Account | Debit | Credit |
|---|---|---|---|
March 31 | Accounts payable | 1,000 | |
Cash | 1,000 | ||
(To record payment of purchases on account) |
That’s how I analyze transactions. I get that it might take some time to become quick at it because it’s not easy, but once you master the technique I showed you, analyzing debits and credits will start to feel like second nature.
Common Misconceptions About Debits and Credits
Talking about debits and credits probably won’t spark a conversation the way quantum mechanics might. That’s why I understand why some people misunderstand the concept. I’ll debunk these misconceptions so that you can really understand how they work.
Misconception | Why It’s Not True |
|---|---|
Debits always mean an increase, and credits always mean a decrease. | Debits and credits are just ways to adjust the balance of an account. Increasing or decreasing account balances depend on the account type. For example, increasing an asset means debiting it, whereas increasing a liability means crediting it. |
The rules of debit and credit are the same as debit and credit cards. | Debits and credits in accounting aren’t the same as those in banking. Debit cards pull directly from your bank account, reducing your balance. Credit cards borrow funds, increasing your liability. |
Debits mean inflows, and credits mean outflows. | Under accrual accounting, debits and credits aren’t always inflows and outflows. For example, when you pay an electric bill, the amount is recorded as an expense, and increasing expenses means debiting the account. So, do you still think debits always mean inflow, when debiting an expense actually represents an outflow? |
When a debit increases an account, a credit must decrease another account. | This is incorrect. Thinking about debits and credits in this way contradicts the foundational rules discussed earlier. Suppose we sell goods to a customer for $1,000 on account. The journal entry would debit Accounts Receivable and credit Sales for $1,000.
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Frequently Asked Questions (FAQs)
Debits and credits are simply the two sides of an account. They are neither increases nor decreases because they depend on the transaction and account type.
It depends. Debit is money-in if it increases assets related to cash, like cash on hand or cash in bank. It is money-out if it decreases cash assets such as payment of liabilities or expenses.
A debit can be positive or negative, depending on the account’s normal balance. If an account’s normal balance is a debit and shows a debit balance, then the account is considered positive. However, if the normal balance is debit but the account has a credit balance, it indicates a negative balance.
Bottom Line
Debits and credits can be tricky, but they don’t have to be. Just remember the technique I showed you. There’s no need to memorize normal balances—just apply the concept, and you’ll be able to analyze any transaction with confidence.
