ACCOUNTING BASICS

Introduction to Debits and Credits

If the words "debits" and "credits" sound like a foreign language to you, you are more perceptive
than you realize—"debits" and "credits" are words that have been traced back five hundred years
to a document describing today's double-entry accounting system.

Under the double-entry system every business transaction is recorded in at least two accounts.
One account will receive a "debit" entry, meaning the amount will be entered on the left side of
that account. Another account will receive a "credit" entry, meaning the amount will be entered
on the right side of that account. The initial challenge with double-entry is to know which account
should be debited and which account should be credited.
Before we explain and illustrate the debits and credits in accounting and bookkeeping, we will
discuss the accounts in which the debits and credits will be entered or posted.

Debit and Credit Definitions

Business transactions are events that have a monetary impact on the financial statements of an
organization. When accounting for these transactions, we record numbers in two accounts, where
the debit column is on the left and the credit column is on the right.

 A debit is an accounting entry that either increases an asset or expense account, or decreases a
liability or equity account. It is positioned to the left in an accounting entry.
 A credit is an accounting entry that either increases a liability or equity account, or decreases an
asset or expense account. It is positioned to the right in an accounting entry.

Debit and Credit Usage

Whenever you create an accounting transaction, at least two accounts are always impacted,
with a debit entry being recorded against one account and a credit entry being recorded against
the other account. There is no upper limit to the number of accounts involved in a transaction -
but the minimum is no less than two accounts. The totals of the debits and credits for any
transaction must always equal each other, so that an accounting transaction is always said to be
"in balance." If a transaction were not in balance, then it would not be possible to create financial
statements. Thus, the use of debits and credits in a two-column transaction recording format is the
most essential of all controls over accounting accuracy.

There can be considerable confusion about the inherent meaning of a debit or a credit. For
example, if you debit a cash account, then this means that the amount of cash on
hand increases. However, if you debit an accounts payable account, this means that the amount
of accounts payable liability decreases. These differences arise because debits and credits have
different impacts across several broad types of accounts, which are:

 Asset accounts. A debit increases the balance and a credit decreases the balance.
 Liability accounts. A debit decreases the balance and a credit increases the balance.
 Equity accounts. A debit decreases the balance and a credit increases the balance.

The reason for this seeming reversal of the use of debits and credits is caused by the underlying
accounting formula upon which the entire structure of accounting transactions are built, which is:

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Assets = Liabilities + Equity

Thus, in a sense, you can only have assets if you have paid for them with liabilities or equity, so you
must have one in order to have the other. Consequently, if you create a transaction with a debit
and a credit, you are usually increasing an asset while also increasing a liability or equity account
(or vice versa). There are some exceptions, such as increasing one asset account while decreasing
another asset account.

If you are more concerned with accounts that appear on the income statement, then these
additional rules apply:

 Revenue accounts. A debit decreases the balance and a credit increases the balance.
 Expense accounts. A debit increases the balance and a credit decreases the balance.
 Gain accounts. A debit decreases the balance and a credit increases the balance.
 Loss accounts. A debit increases the balance and a credit decreases the balance.

If you are really confused by these issues, then just remember that debits always go in the left
column, and credits always go in the right column. There are no exceptions.

Debit and Credit Rules

The rules governing the use of debits and credits are as follows:

Normal Balances

When looking at a T-account for each of the account classifications in the general ledger, here is
the debit or credit balance you would normally find in the account:

S.NO. CLASS OF TRANSACTION NATURE INCREASE DECREASE

1 Assets Debit Debit Credit
2 Expenses Debit Debit Credit
3 Drawings Debit Debit Credit
4 Capital Credit Credit Debit
5 Income Credit Credit Debit
6 Liability Credit Credit Debit

Tip: Increase is directly proportional to the nature of class and decease is inversely proportional.

 All accounts that normally contain a debit balance will increase in amount when a debit (left
column) is added to them, and reduced when a credit (right column) is added to them. The types
of accounts to which this rule applies are expenses, assets, and dividends.
 All accounts that normally contain a credit balance will increase in amount when a credit (right
column) is added to them, and reduced when a debit (left column) is added to them. The types
of accounts to which this rule applies are liabilities, revenues, and equity.
 The total amount of debits must equal the total amount of credits in a transaction. Otherwise, an
accounting transaction is said to be unbalanced, and will not be accepted by the accounting
software.

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Debits and Credits in Common Accounting Transactions

The following bullet points note the use of debits and credits in the more common business
transactions:

 Sale for cash: Debit the cash account | Credit the revenue account
 Sale on credit: Debit the accounts receivable account | Credit the revenue account
 Receive cash in payment of an account receivable: Debit the cash account | Credit the
accounts receivable account
 Purchase supplies from supplier for cash: Debit the supplies expense account | Credit the cash
account
 Purchase supplies from supplier on credit: Debit the supplies expense account | Credit the
accounts payable account
 Purchase inventory from supplier for cash: Debit the inventory account | Credit the cash account
 Purchase inventory from supplier on credit: Debit the inventory account | Credit the accounts
payable account
 Pay employees: Debit the wages expense and payroll tax accounts | Credit the cash account
 Take out a loan: Debit cash account | Credit loans payable account
 Repay a loan: Debit loans payable account | Credit cash account

Debit and Credit Examples

Arnold Corporation sells a product to a customer for $1,000 in cash. This results in revenue of $1,000
and cash of $1,000. Arnold must record an increase of the cash (asset) account with a debit, and
an increase of the revenue account with a credit. The entry is:

Debit Credit
Cash 1,000
Revenue 1,000

Arnold Corporation also buys a machine for $15,000 on credit. This results in an addition to the
Machinery fixed assets account with a debit, and an increase in the accounts payable (liability)
account with a credit. The entry is:

Debit Credit
Machinery - Fixed Assets 15,000
Accounts Payable 15,000

Other Debit and Credit Issues

A debit is commonly abbreviated as dr. in an accounting transaction, while a credit is

abbreviated as cr. in an accounting transaction.

Debits and credits are not used in a single entry system. In this system, only a single notation is
made of a transaction; it is usually an entry in a check book or cash journal, indicating the receipt
or expenditure of cash. A single entry system is only designed to produce an income statement.

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What Is An Account?

To keep a company's financial data organized, accountants developed a system that sorts
transactions into records called accounts. When a company's accounting system is set up, the
accounts most likely to be affected by the company's transactions are identified and listed out.
This list is referred to as the company's chart of accounts. Depending on the size of a company
and the complexity of its business operations, the chart of accounts may list as few as thirty
accounts or as many as thousands. A company has the flexibility of tailoring its chart of accounts
to best meet its needs.
Within the chart of accounts, the balance sheet accounts are listed first, followed by the income
statement accounts. In other words, the accounts are organized in the chart of accounts as
follows:

 Assets
 Liabilities
 Owner's (Stockholders') Equity
 Revenues or Income
 Expenses
 Gains
 Losses

Introduction to Chart of Accounts

A chart of accounts is a listing of the names of the accounts that a company has identified and
made available for recording transactions in its general ledger. A company has the flexibility to
tailor its chart of accounts to best suit its needs, including adding accounts as needed.
Within the chart of accounts, you will find that the accounts are typically listed in the following
order:

Within the categories of operating revenues and operating expenses, accounts might be further
organized by business function (such as producing, selling, administrative, financing) and/or by
company divisions, product lines, etc.

A company's organization chart can serve as the outline for its accounting chart of accounts. For
example, if a company divides its business into ten departments (production, marketing, human

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resources, etc.), each department will likely be accountable for its own expenses (salaries,
supplies, phone, etc.). Each department will have its own phone expense account, its own salaries
expense, etc.
A chart of accounts will likely be as large and as complex as the company itself. An international
corporation with several divisions may need thousands of accounts, whereas a small local retailer
may need as few as one hundred accounts.

Sample Chart of Accounts for a Large Corporation

Each account in the chart of accounts is typically assigned a name and a unique number by
which it can be identified. (Software for some small businesses may not require account numbers.)
Account numbers are often five or more digits in length with each digit representing a division of
the company, the department, the type of account, etc.

As you will see, the first digit might signify if the account is an asset, liability, etc. For example, if the
first digit is a "1" it is an asset. If the first digit is a "5" it is an operating expense.

A gap between account numbers allows for adding accounts in the future. The following is
a partial listing of a sample chart of accounts.

Current Assets (account numbers 10000 - 16999)

10100 Cash - Regular Checking

10200 Cash - Payroll Checking
10600 Petty Cash Fund
12100 Accounts Receivable
12500 Allowance for Doubtful Accounts
13100 Inventory
14100 Supplies
15300 Prepaid Insurance

Property, Plant, and Equipment (account numbers 17000 - 18999)

17000 Land
17100 Buildings
17300 Equipment
17800 Vehicles
18100 Accumulated Depreciation - Buildings
18300 Accumulated Depreciation - Equipment
18800 Accumulated Depreciation - Vehicles

Current Liabilities (account numbers 20020 - 24999)

20120 Notes Payable - Credit Line #1

20220 Notes Payable - Credit Line #2
21000 Accounts Payable

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22100 Wages Payable

23100 Interest Payable
24500 Unearned Revenues

Long-term Liabilities (account numbers 25000 - 26999)

25100 Mortgage Loan Payable

25600 Bonds Payable
25650 Discount on Bonds Payable

Stockholders' Equity (account numbers 27000 - 29999)

27100 Common Stock, No Par

27500 Retained Earnings
29500 Treasury Stock

Operating Revenues (account numbers 30000 - 39999)

31010 Sales - Division #1, Product Line 010

31022 Sales - Division #1, Product Line 022
32017 Sales - Division #2, Product Line 015
33110 Sales - Division #3, Product Line 110

Cost of Goods Sold (account numbers 40000 - 49999)

41010 COGS - Division #1, Product Line 010

41022 COGS - Division #1, Product Line 022
42017 COGS - Division #2, Product Line 015
43110 COGS - Division #3, Product Line 110

Marketing Expenses (account numbers 50000 - 50999)

50100 Marketing Dept. Salaries

50150 Marketing Dept. Payroll Taxes
50200 Marketing Dept. Supplies
50600 Marketing Dept. Telephone

Payroll Dept. Expenses (account numbers 59000 - 59999)

59100 Payroll Dept. Salaries

59150 Payroll Dept. Payroll Taxes
59200 Payroll Dept. Supplies
59600 Payroll Dept. Telephone

Other (account numbers 90000 - 99999)

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91800 Gain on Sale of Assets

96100 Loss on Sale of Assets

Double-Entry Accounting

Because every business transaction affects at least two accounts, our accounting system is known
as a double-entrysystem. (You can refer to the company's chart of accounts to select the proper
accounts. Accounts may be added to the chart of accounts when an appropriate account
cannot be found.)
For example, when a company borrows $1,000 from a bank, the transaction will affect the
company's Cash account and the company's Notes Payable account. When the company
repays the bank loan, the Cash account and the Notes Payable account are also involved.
If a company buys supplies for cash, its Supplies account and its Cash account will be affected. If
the company buys supplies on credit, the accounts involved are Supplies and Accounts Payable.
If a company pays the rent for the current month, Rent Expense and Cash are the two accounts
involved. If a company provides a service and gives the client 30 days in which to pay, the
company's Service Revenues account and Accounts Receivable are affected.
Although the system is referred to as double-entry, a transaction may involve more than two
accounts. An example of a transaction that involves three accounts is a company's loan payment
to its bank of $300. This transaction will involve the following accounts: Cash, Notes Payable, and
Interest Expense.

(If you use accounting software you may not actually see that two or more accounts are being
affected due to the user-friendly nature of the software. For example, let's say that you write a
company check by means of your accounting software. Your software automatically reduces
your Cash account and prompts you only for the other accounts affected.)
Special Feature: Review what you are learning by working the three interactive crossword puzzles
dedicated to this topic. They are completely free.
Click here for the Debits and Credits Crossword Puzzles

Debits and Credits

After you have identified the two or more accounts involved in a business transaction, you must
debit at least one account and credit at least one account.

To debit an account means to enter an amount on the left side of the account. To credit an
account means to enter an amount on the right side of an account.

Here's a Tip
Debit means left
Credit means right

Generally, these types of accounts are increased with a debit:

Dividends (Draws)
Expenses

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Assets
Losses
You might think of D - E - A - L when recalling the accounts that are increased with a debit.
Generally, these types of accounts are increased with a credit:
Gains
Income
Revenues
Liabilities
Stockholders' (Owner's) Equity
You might think of G - I - R - L - S when recalling the accounts that are increased with a credit.
To decrease an account, you do the opposite of what was done to increase the account. For
example, an asset account is increased with a debit. Therefore, it is decreased with a credit.
The abbreviation for debit is dr. and the abbreviation for credit is cr.

T-accounts

Accountants and bookkeepers often use T-accounts as a visual aid for seeing the effect of the
debit and credit on the two (or more) accounts. (Learn more about accountants and
bookkeepers in our Accounting Career Center.)
We will begin with two T-accounts: Cash and Notes Payable.

Let's demonstrate the use of these T-accounts with two transactions:

1. On June 1, 2015 a company borrows $5,000 from its bank. This causes the company's asset
Cash to increase by $5,000 and its liability Notes Payable to also increase by $5,000. To
increase the asset Cash, the account needs to be debited. To increase the company's
liability Notes Payable this account needs to be credited. After entering the debits and
credits the T-accounts look like this:

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2. On June 2, 2015 the company repaid $2,000 of the bank loan. This causes the company's
asset Cash to decrease by $2,000 and its liability Notes Payable to also decrease by $2,000.
To reduce the asset Cash the account will need to be credited for $2,000. To decrease the
liability Notes Payable that account will need to be debited. The T-accounts now look like
this:

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Journal Entries

Another way to visualize business transactions is to write a general journal entry. Each general
journal entry lists the date, the account title(s) to be debited and the corresponding amount(s)
followed by the account title(s) to be credited and the corresponding amount(s). The accounts
to be credited are indented. Let's illustrate the general journal entries for the two transactions that
were shown in the T-accounts above.

When Cash Is Debited and Credited

Because cash is involved in many transactions, it is helpful to memorize the following:

 Whenever cash is received, debit Cash.

 Whenever cash is paid out, credit Cash.
With the knowledge of what happens to the Cash account, the journal entry to record the debits
and credits is easier. Let's assume that a company receives $500 on June 3, 2015 from a customer
who was given 30 days in which to pay. (In May the company recorded the sale and an accounts
receivable.) On June 3 the company will debit Cash, because cash was received. The amount of
the debit and the credit is $500. Entering this information in the general journal format, we have:

All that remains to be entered is the name of the account to be credited. Since this was the
collection of an account receivable, the credit should be Accounts Receivable. (Because the
sale was already recorded in May, you cannot enter Sales again on June 3.)
On June 4 the company paid $300 to a supplier for merchandise the company received in May.
(In May the company recorded the purchase and the accounts payable.) On June 4 the
company will credit Cash, because cash was paid. The amount of the debit and credit is $300.
Entering them in the general journal format, we have:

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All that remains to be entered is the name of the account to be debited. Since this was the
payment on an account payable, the debit should be Accounts Payable. (Because the purchase
was already recorded in May, you cannot enter Purchases or Inventory again on June 4.)
To help you become comfortable with the debits and credits in accounting, memorize the
following tip:

Here's a Tip

Whenever cash is received, the Cash account is debited (and another account is credited).
Whenever cash is paid out, the Cash account is credited (and another account is debited).

Revenues and Gains Are Usually Credited

Revenues and gains are recorded in accounts such as Sales, Service Revenues, Interest
Revenues (or Interest Income), and Gain on Sale of Assets. These accounts normally have credit
balances that are increased with a credit entry.
The exceptions to this rule are the accounts Sales Returns, Sales Allowances, and Sales Discounts—
these accounts have debit balances because they are reductions to sales. Accounts with
balances that are the opposite of the normal balance are called contra accounts; hence contra
revenue accounts will have debit balances.
Let's illustrate revenue accounts by assuming your company performed a service and was
immediately paid the full amount of $50 for the service. The debits and credits are presented in
the following general journal format:

Whenever cash is received, the asset account Cash is debited and another account will need to
be credited. Since the service was performed at the same time as the cash was received, the
revenue account Service Revenues is credited, thus increasing its account balance.

Let's illustrate how revenues are recorded when a company performs a service on credit (i.e., the
company allows the client to pay for the service at a later date, such as 30 days from the date of
the invoice). At the time the service is performed the revenues are considered to have been
earned and they are recorded in the revenue account Service Revenues with a credit. The other

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account involved, however, cannot be the asset Cash since cash was not received. The account
to be debited is the asset account Accounts Receivable. Assuming the amount of the service
performed is $400, the entry in general journal form is:

Accounts Receivable is an asset account and is increased with a debit; Service Revenues is
increased with a credit.

Expenses and Losses are Usually Debited

Expenses normally have their account balances on the debit side (left side). A debit increases the
balance in an expense account; a credit decreases the balance. Since expenses are usually
increasing, think "debit" when expenses are incurred. (We credit expenses only to reduce them,
adjust them, or to close the expense accounts.) Examples of expense accounts include Salaries
Expense, Wages Expense, Rent Expense, Supplies Expense, and Interest Expense.
To illustrate an expense let's assume that on June 1 your company paid $800 to the landlord for
the June rent. The debits and credits are shown in the following journal entry:

Since cash was paid out, the asset account Cash is credited and another account needs to be
debited. Because the rent payment will be used up in the current period (the month of June) it is
considered to be an expense, and Rent Expense is debited. If the payment was made on June 1
for a future month (for example, July) the debit would go to the asset account Prepaid Rent.
As a second example of an expense, let's assume that your hourly paid employees work the last
week in the year but will not be paid until the first week of the next year. At the end of the year,
the company makes an entry to record the amount the employees earned but have not been
paid. Assuming the employees earned $1,900 during the last week of the year, the entry in general
journal form is:

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As noted above, expenses are almost always debited, so we debit Wages Expense, increasing its
account balance. Since your company did not yet pay its employees, the Cash account
is not credited, instead, the credit is recorded in the liability account Wages Payable. A credit to
a liability account increases its credit balance.
To help you get more comfortable with debits and credits in accounting and bookkeeping,
memorize the following tip:

Here's a Tip
To increase an expense account, debit the account.

Permanent and Temporary Accounts

Asset, liability, and most owner/stockholder equity accounts are referred to as "permanent
accounts" (or "real accounts"). Permanent accounts are not closed at the end of the accounting
year; their balances are automatically carried forward to the next accounting year.
"Temporary accounts" (or "nominal accounts") include all of the revenue accounts, expense
accounts, the owner drawing account, and the income summary account. Generally speaking,
the balances in temporary accounts increase throughout the accounting year and are "zeroed
out" and closed at the end of the accounting year.
Balances in the revenue and expense accounts are zeroed out by closing/transferring/clearing
their balances to the Income Summary account. The net amount in Income Summary is then
closed/transferred/cleared to an owner equity account, such as Mary Smith, Capital (or
to Retained Earnings if the company is a corporation). The owner drawing account (such as Mary
Smith, Drawing) is a temporary account and it is closed directly to the owner capital account
(such as Mary Smith, Capital) without going through an income summary account.
Because the balances in the temporary accounts are transferred out of their respective accounts
at the end of the accounting year, each temporary account will have a zero balance when the
next accounting year begins. This means that the new accounting year starts with no revenue
amounts, no expense amounts, and no amount in the drawing account.

By using many revenue accounts and a huge number of expense accounts, a company is certain
to have easy access to detailed information on revenues and expenses throughout the year. This
allows the management of the company to monitor the performance of all parts of the company.
Once the accounting year has ended, the need to know the balances in these temporary
accounts has also ended, so the accounts are closed out and reopened for the next accounting
year with zero balances.

Bank's Debits and Credits

When you hear your banker say, "I'll credit your checking account," it means the transaction
will increase your checking account balance. Conversely, if your bank debits your account (e.g.,
takes a monthly service charge from your account) your checking account balance decreases.
If you are new to the study of debits and credits in accounting, this may seem puzzling. After all,
you learned that debiting the Cash account in the general ledger increases its balance, yet your
bank says it is crediting your checking account to increase its balance. Similarly, you learned
that crediting the Cash account in the general ledger reduces its balance, yet your bank says it
is debiting your checking account to reduce its balance.

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Although the above may seem contradictory, we will illustrate below that a bank's treatment of
debits and credits is indeed consistent with the basic accounting principles you learned. Let's look
at three transactions and consider the resultant journal entries from both the bank's perspective
and the company's perspective.

Transaction #1
Let's say that your company, Debris Disposal, receives $100 of currency from a customer as a down
payment for a future site cleanup service. When the money is received your company makes the
following entry:

(Debris Disposal's journal entry)

Because it has received cash, Debris Disposal increases its Cash account with a debit of $100. The
rules of double entry accounting require Debris Disposal to also enter a credit of $100 into another
of its general ledger accounts. Since the company has not yet earned the $100, it cannot credit
a revenue account. Instead, the liability account Unearned Revenues is credited because Debris
Disposal has a liability to do the work or to return the $100. (An alternate title for the Unearned
Revenues account is Customer Deposits.)
Now let's say you take that $100 to Trustworthy Bank and deposit it into Debris Disposal's checking
account. Trustworthy Bank debits the bank's general ledger Cash account for $100, thereby
increasing the bank's assets. The rules of double entry accounting require the bank to also enter
a credit of $100 into another of bank's general ledger accounts. Because the bank has
not earned the $100, it cannot credit a revenue account. Instead, the bank credits its liability
account Deposits to reflect the bank's obligation/liability to return the $100 to Debris Disposal on
demand. In general journal format the bank's entry is:
(Trustworthy Bank's journal entry)

As the entry shows, the bank's assets increase by the debit of $100 and the bank's liabilities increase
by the credit of $100. The bank's detailed records show that Debris Disposal's checking account is
the specific liability that increased.

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Transaction #2
Let's say Trustworthy Bank receives a $1,000 wire transfer on your company's behalf from a person
who owes money to Debris Disposal. Two things happen at the bank: (1) The bank receives $1,000,
and (2) the bank records its obligation to give the money to Debris Disposal on demand. These
two facts are entered into the bank's general ledger as follows:

(Trustworthy Bank's journal entry)

The debit increases the bank's assets by $1,000 and the credit increases the bank's liabilities by
$1,000. The bank's detailed records show that Debris Disposal's checking account is the specific
liability that increased.

At the same time the $1,000 wire transfer is received at the bank, Debris Disposal makes the
following entry into its general ledger:

(Debris Disposal's journal entry)

As a result of collecting $1,000 from one of its customers, Debris Disposal's Cash balance increases
and its Accounts Receivable balance decreases.

Transaction #3

Many banks charge a monthly fee on checking accounts. If Trustworthy Bank decreases Debris
Disposal's checking account balance by $13.00 to pay for the bank's monthly service charge, this
might be itemized on Debris Disposal's bank statement as a "debit memo." The entry in the bank's
records will show the bank's liability being reduced (because the bank owes Debris Disposal $13
less). It also shows that the bank earned revenues of $13 by servicing the checking account.

(Trustworthy Bank's general ledger)

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On your company's records, the entry will look like this:

(Debris Disposal's general ledger)

Debris Disposal's cash is reduced with a credit of $13 and expenses are increased with a debit of
$13. (If the amount of the bank's service charges is not significant a company may debit the
charge to Miscellaneous Expense.)

Bank's Balance Sheet

Accounts such as Cash, Investment Securities, and Loans Receivable are reported as assets on
the bank's balance sheet. Deposits are reported as liabilities and include the balances in its
customers' checking and savings accounts as well as certificates of deposit. In effect, your bank
statement is just one of thousands of subsidiary records that account for millions of dollars in
Deposits that a bank owes to its customers.

Recap

Here are some of the highlights from this major topic:

 Debit means left.

 Credit means right.
 Every transaction affects two accounts or more.
 At least one account will be debited and at least one account will be credited.
 The total of the amount(s) entered as debits must equal the total of the amount(s) entered
as credits.
 When cash is received, debit Cash.
 When cash is paid out, credit Cash.
 To increase an asset, debit the asset account.
 To increase a liability, credit the liability account.

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 To increase owner's equity, credit an owner's equity account.

 To increase revenues, credit the revenues account
 To increase expenses, debit the expense account
Additional Information and Resources

Because the material covered here is considered an introduction to this topic, many complexities
have been omitted. You should always consult with an accounting professional for assistance with
your own specific circumstances.

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