Debits and credits are two key terms that are crucial in understanding the fundamental accounting concepts. These key terms are used for bookkeeping to record any type of financial transaction. The words debit and credit can be used to describe either a change in an account or to identify the account balance. Debits and credits are neither good nor bad, and no term is of greater or less importance than the other. The terms debit and credit are of equal value. It is important to briansclub understand how debits and credits work before advancing into upper level accounting classes.
In order to further understand the concepts behind debits and credits, it is important to know how they are recorded in the books for financial transactions. Financial transactions are recorded by using a debit (DR) or a credit (CR) balance. Debits are recorded when dealing with asset and expense transactions. Credits are used to record liability and equity transactions. When recording transactions in the books, a credit balance is reduced by a debit, and vice versa. For most transactions, whatever is being received is the account that is debited, and what is given is credited. To record financial transactions, one would post entries to T-Accounts in the general ledger and then journalize transactions in the general journal. The numbers are separated into two columns. The debits are on one side of the column and the credits are on the other side. By recording debit and credit transactions on opposite sides, it is easier to keep track of each account. A ledger account has a debit balance when the debit value amounts are lower than the credit amounts. An account can have a debit or a credit balance; however it cannot have a balance of both. A debit may also be used to reduce a credit account. For instance, a debit can reduce the balance of a liability or equity account. On the other hand, a credit can be used to reduce the balance of an asset or expense account. When an asset is recorded in a transaction, the account is debited or increased, and the credit side is decreased. For personal accounts, the receiver is debited and the giver is credited. For asset accounts, what comes in is debited and what goes out is credited. For expense accounts, losses and expenses are debited, and income/gains are credited. Every transaction recorded in the books contains debits and credits. The value of the debits MUST equal the value of credits for every financial transaction.
Another concept that is important to grasp when understanding debits and credits is the accounting equation. The accounting equation is simply assets/expenses= liabilities + owner’s equity (A=L+OE). Just as debits and credits must balance, the accounting equation must balance as well. The debit accounts within the accounting equation are assets and expenses. The credit accounts are liabilities and owner’s equity. After financial transactions are recorded in the general journal, they are then placed into a financial statement. Three financial statements used in accounting are the balance sheet, statement of retained earnings, and the income statement. Only assets are recorded on the balance sheet, and the other accounts are recorded on the statement of retained earnings and the income statement.
Examples of financial transactions:
1) A student at West Chester University pays $718 cash for her apartment’s monthly rent.
• Since rent is an expense account, this account is increased by recording a debit on the left side.
• Since cash is given for the rent, this account is decreased and credited on the right side.
• In other words, rent expense is debited and cash is credited.
2) A dance studio owner receives $25 revenue in cash for dance classes.
• Since cash is received, this account would be increased with a debit transaction.
• A credit transaction would occur by increasing the revenue account with a credit.
• In other words, cash is debited and revenue is credited.
3) A company buys office equipment for $50 cash.
• Since office equipment is something that is owned, it is recorded as an asset account.
• In this transaction, office equipment is debited.
• Since cash is being paid, cash is credited.
4) The manager of a company pays $100 cash for an employee’s weekly salary.
• Since salary is an expense account, salaries expense would be debited for $100.
• Cash is given in this transaction, so therefore cash is credited.
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