Debits and credits represent the right and left sides of the accounting equation and are the foundation of the double-entry accounting system. As an accounting professor, I’ve had the honor to teach this fundamental of bookkeeping to hundreds of beginning accounting students and have settled on the following definitions for debits and credits: debits are on the left and credits are on the right.
Before you decide this definition is useless and click away, give me a chance to explain it further in this short article.
Tip: A common misconception is that credits are positive and debits are negative. This isn’t true. Debits increase certain accounts while credits increase other accounts. Read on to learn more.
Debits and Credits on Financial Statements
Balance Sheet
The balance sheet is composed of a left (debit) and right (credit) side and represents the basic accounting equation:
Accounting Equation | ||
|---|---|---|
Debits | Credits | |
Assets | = | Liabilities + Owners’ Equity |
Since assets are on the left side of the equation, an asset account increases with a debit entry and decreases with a credit entry. Conversely, liabilities are on the right side of the equation, so they are increased by credits and decreased by debits. The same is true for owners’ equity, but it contains net income that needs a little more explanation, which we’ll do in the next section. Owners’ equity accounts represent an owner’s investment in the company and consist of capital contributed to the company and earnings retained by the company.
Normal balance: Accounts that are increased with a debit have a debit normal balance. Accounts increased with a credit have a normal balance of a credit.
Balance Sheet | |||
|---|---|---|---|
Normal Balance | Normal Balance | ||
Assets | Debit | Liabilities | Credit |
Owners’ Equity | Credit | ||
Net Income (From Income statement) | Credit | ||
Income Statement
Remember that owners’ equity has a normal balance of a credit. Therefore, income statement accounts that increase owners’ equity have credit normal balances, and accounts that decrease owners’ equity have debit normal balances.
When a company earns money, it records revenue, which increases owners’ equity. Therefore, you must credit a revenue account to increase it, or it has a credit normal balance. Expenses are the result of a company spending money, which reduces owners’ equity. Therefore, expense accounts have a debit normal balance.
If revenues (credits) exceed expenses (debits) then net income is positive and a credit balance. If expenses exceed revenues, then net income is negative (or a net loss) and has a debit balance.
Income Statement | |
|---|---|
Normal Balance | |
Revenue | Credit |
Less Expenses | Debit |
Equals Net Income | Credit |
Debit and Credit Effects by Account Type
Assets
As discussed in the balance sheet section above, assets are increased by debits and decreased by credits. Asset accounts include:
- Cash
- Bank accounts
- Accounts receivable (A/R)
- Investments
- Fixed assets
Q: If bank accounts are increased by debits, why does my checking account statement show deposits as credits?
A: Your bank statement is from the point of view of your bank. From their viewpoint, your checking account is a liability because they owe that money to you. As a liability on the right side of their balance sheet, the checking account is increased with a credit.
Contra Asset Accounts
Contra asset accounts appear on the left side of the balance sheet along with assets, but they decrease the value of assets. Since they decrease assets, a contra asset account is increased with credits and decreased with debits. The most common contra asset accounts are:
- Allowance for doubtful accounts
- Accumulated depreciation
Liabilities
Liabilities are on the right side of the balance sheet and, therefore, are increased by credit and decreased by debits. Common liability accounts include:
- Accounts payable (A/P)
- Credit card debt
- Loans payable
- Loans due to shareholders
Owners’ Equity
Owners’ Equity accounts are located on the right side of the balance sheet and are thus increased by credits and decreased by debits. The most common equity accounts are:
- Paid-in capital
- Common stock
- Retained earnings
- Current period net income
Income
Income accounts increase owners’ equity on the balance sheet. You must credit an income account to record income. Examples of some income accounts include:
- Sales
- Rents received
- Interest received
- Gain on sale
Expense
Expenses decrease owners’ equity and therefore have a debit normal balance. Examples of expense accounts include:
- Wages
- Interest paid
- Taxes paid
- Operating expenses
- Cost of goods sold
Debits and Credits in Transactions
In accounting, account balances are adjusted by recording transactions. Transactions always include debits and credits, and the debits and credits must always be equal for the transaction to balance. If a transaction didn’t balance, then the balance sheet would no longer balance, and that’s a big problem.
Here’s how an accounting transaction is typically presented:
Account | Debit | Credit |
|---|---|---|
Interest Expense | $100 | |
Credit Card Payable | $4,000 | |
Checking Account | $4,100 |
While there are two debit entries and only one credit entry, the total dollar amount of debits and credits are equal, which means the transaction is in balance.
Let’s use what we’ve learned about debits and credits to determine what this accounting transaction is recording. The first step is to determine the type of accounts being adjusted and whether they have a debit or credit normal balance.
Account Name | Account Type | Normal Balance |
|---|---|---|
Interest Expense | Expense | Debit |
Credit Card Payable | Liability | Credit |
Checking Account | Asset | Debit |
Now we can compare the normal balance of each account to the transaction being recorded to understand the effect on the account:
- Interest expense is debited, so it’s increasing by $100
- Credit card payable is debited, so it’s decreasing by $4,000
- Checking account is credited, so it’s decreasing by $4,100
So, what transactions did we record? A check was written for $4,100 to pay $100 of interest expense and $4,000 of principal on our credit card. The effect on the balance sheet was:
- Assets decreased by $4,100
- Liabilities decreased by $4,000
- Owners’ Equity decreased by $100
Example Transactions With Debits and Credits
Here are some examples of common journal entries along with their debits and credits. I’ve also added a column that shows the effect that each line of the journal entry has on the balance sheet.
1. Record Cash Sales of Inventory
The company makes a cash sale of inventory to a customer for $100. The company paid $75 for the inventory.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Cash | $100 | Assets increase | |
Sales | $100 | Owner’s equity increases |
2. Record Sales of Services on Credit
The company bills a customer $500 for services performed. Since this is a service, no cost of goods sold is recorded.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Accounts Receivable | $500 | Assets increase | |
Sales | $500 | Owner’s equity increases |
3. Record a Customer Payment on a Previous Credit Sale
A customer pays $500 on an outstanding invoice that was previously recorded as a credit sale.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Cash | $500 | Assets increase | |
Accounts Receivable | $500 | Assets increase |
4. Record Depreciation Expense
The company records $1,000 of depreciation expense.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Depreciation Expense | $1,000 | Owner’s equity decreases | |
Accumulated Depreciation | $1,000 | Assets decrease |
5. Record the Sale of a Fixed Asset
The company sales a fixed asset for $3,500 cash. The company originally paid $4,000 for the asset and has claimed $1,000 of depreciation expense.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Cash | $3,500 | Assets increase | |
Accumulated Depreciation | $1,000 | Assets increase | |
Fixed Asset | $4,000 | Assets decrease | |
Gain on Sale | $500 | Owner’s equity increases |
6. Record the Payment of a Cash Expense
The company pays $100 cash for supplies.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Supplies Expense | $100 | Owner’s equity decreases | |
Checking Account | $100 | Assets decrease |
7. Record an Expense Purchased on Vendor Credit
The company purchases $500 of supplies from a vendor and receives an invoice, but doesn’t pay the invoice yet.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Supplies Expense | $500 | Owner’s equity decreases | |
Accounts Payable | $500 | Liabilities increase |
8. Record the Payment of an Amount Owed to Vendor
The company pays an outstanding vendor invoice of $500 that was previously recorded as an expense.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Accounts Payable | $500 | Liabilities Decrease | |
Checking Account | $500 | Assets Decrease |
9. Record Inventory Purchased for Cash
The company purchases inventory for $1,500 cash.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Inventory | $1,500 | Assets Increase | |
Cash | $1,500 | Assets Decrease |
10. Record the Purchase of Fixed Assets
The company purchases equipment for $10,000 with $2,000 cash and an $8,000 loan.
Account | Debit | Credit | Balance Sheet Effect |
|---|---|---|---|
Equipment | $10,000 | Assets Increase | |
Cash | $2,000 | Assets Decrease | |
Note Payable | $8,000 | Liabilities Increase |
Bottom Line
For someone learning about accounting, understanding debits and credits can be confusing. The easiest way to remember them is that debits are on the left and credits are on the right. This means debits increase the left side of the balance sheet and accounting equation, while credits increase the right side.
