This article explains the logic of utilizing debits and credits in the recording of transactions.
Accounting ends with score keeping but begins with record keeping. The first task of accounting is to accurately record transactions. Transactions are events that change the composition of a firm’s assets, liabilities, and equity.
Transactions are typically first recorded in specialized records called books of original entry. The most commonly used of these are the cash receipts and cash disbursements journals. These can be actual books or registers or virtual as in accounting software.
The most accurate and reliable method of record keeping utilizes computer software to create and print checks. Such software automatically stores a complete record of the transaction as checks are generated. The information captured from a recorded transaction is more important than the form used in recording it. At a minimum, the written record should include the date of the transaction, the parties involved, the dollar amounts disbursed or collected, and the nature of the transaction.
Information contained in these books of original entry must be transferred or posted to general ledger accounts. The collection of all accounts is called the general ledger. All general ledger accounts should be thought of as specially formatted records shaped as a big “T”. For example think of the Cash account as looking like this:
The importance of the “T” structure is that it distinguishes between the left and right side of each general ledger account. Instead of saying “left side” and “right side” accountants use the terms “debit” and “credit”. “Debit” simply means the left side of the “T” account, and “credit” refers to the right side of the “T” account. But remember:
“Debit” does not always refer to an increase in an account balance nor does “credit” always refer to a decrease, or vice versa. Most importantly, “ credit” does not refer to something good and “debit” to something bad. “Debit” means left, “credit” means right. In accounting that is all these terms mean.
Here is the first rule of transaction posting:
Every transaction involves at least one debit and one equal and offsetting credit. If there is more than one debit or credit in a transaction the total of the debits and credits must be equal.
Because assets must always equal the total of liabilities and equity, any increase in one account must be offset with an equal change to another account that maintains this equation. Notice this does not mean that one account necessarily increases when another account decreases. For example if an asset account is increased, the accounting equation can be maintained by increasing a liability or equity account or by decreasing another asset account.
You can visualize this basic rule by looking at the above teeter-totter illustration. For equilibrium to be maintained, the addition or subtraction of weight on one side of the teeter-totter must lead to some compensating addition or subtraction of weight. But the compensating addition or subtraction does not necessarily have to occur on opposite sides of the fulcrum.
When a dollar amount is posted to a specific general ledger account, the account’s cumulative balance increases or decreases depending upon whether the posting is on the left or right side of the “T”. However, postings on the left are not automatically considered increases, just as postings on the right are not automatically decreases.
Whether a posting on the left constitutes an increase or decrease depends upon the nature of the account. Here are the rules:
Increases in asset and expense accounts are recorded on the left side of the “T”, while decreases in assets are recorded on the right side. So to increase an asset we debit it. To decrease it we credit it.
Increases in liability, equity and revenue accounts are reflected on the right side of the “T”, while decreases are reflected on the left side. So to increase a liability we credit it, to decrease a liability we debit it.
The logic of these rules follows directly from the location of the accounts in the basic accounting equation. The left side of the accounting equation includes all the asset accounts and the right side contains all the liability and equity accounts. To increase an asset account, remember that the assets are on the left side of the fundamental equation, and so you record a debit entry on the left side of the “T”. To increase an equity or liability account, remember that these accounts are located on the right side of the fundamental equation, and so you record a credit entry on the right side of the “T”.
To decrease accounts in any category record them on the opposite side of the “T” from their location in the fundamental equation. For example, to decrease an asset account, which is on the left side of the equation, record a credit entry on the right side of the “T”. To decrease a liability or equity account, record a debit entry on the left.
This reasoning also works for revenue and expense accounts. Recall that revenues are increases in equity and expenses are decreases in equity:
Because equity is on the right side of the equation, record an increase in a revenue account on the right side of the “T” account. So to increase revenue we credit it.
On the other hand, because expenses are decreases in equity, they are recorded on the left side of the “T”. So to increase an expense we debit it.
Most transactions posted to revenue accounts are credits. Most transactions posted to expense accounts are debits. Asset, liability, and equity account transactions have substantially equal amounts of increases and decreases. Thus they have a significant amount of both debit and credit postings. The typical cumulative end of period balances are as follows:
If you want to become agile at analyzing and recording transactions you simply have to memorize these posting rules. Here is a table summarizing the posting rules:
All transactions are first recorded in books of original entry on specialized journals, such as the cash disbursements journal. Another widely used journal is called the general journal. In most businesses this journal is used to record non-cash transactions.
A general journal format looks like this:
The date column refers to the date the transaction took place, not necessarily the date the transaction is recorded. The second column refers to the account number associated with the account. In traditional bookkeeping systems accounts are coded according to whether they are assets, liabilities, equity, revenue, or expense. The third column refers to the full name of the account. The next two columns indicate whether the account is to be debited or credited and in what amount. By convention the account to be debited is listed before the account to be credited. The term “credit” is often abbreviated “Cr”, while debit is abbreviated “Dr” (from the German word “drek”).