In this article, we will break down the fundamentals of recording debits and credits, as well as illustrate how they operate in different types of accounts.
Double Entry Accounting
Most businesses, including small businesses and sole proprietorships, use the double entry accounting method. This is because it allows for a better, dynamic financial picture, where every business transaction is recorded in at least two accounts.
Debit vs. Credit in Accounting
When thinking about debits and credits, consider them together. There should never be a debit without a credit and vice versa. For every debit (monetary amount) recorded, there must be an equal amount entered as a credit to balance that transaction.
Debits and Credits in Different Account Types
Even the smallest businesses and sole proprietorships benefit from accurate bookkeeping. Debits and credits are essential for balancing books and maintaining an accurate financial statement, which provides an overall picture of a company’s assets, liabilities, and equity or shareholder’s equity. The financial statement depends on the basic accounting equation: Assets = Liabilities + Equity.
There are five main accounts that make up a company’s chart of accounts, along with numerous sub-accounts that fall under each category. These accounts can be tailored to the needs of the business. For example, a restaurant is likely to use accounts payable frequently, but it may not have accounts receivable, as money is collected immediately for most transactions.
A single transaction can have debits and credits in many sub-accounts within these categories, which is why accurate recording is essential. Below is a breakdown of each type of account:
Assets
Assets are items owned by the company that can be sold or used to produce products. This applies to tangible (physical) items such as equipment as well as intangible items like patents. Some types of asset accounts are categorized as current assets, which include cash accounts, accounts receivable, and inventory. Current assets contrast with long-term assets, which include items like property, plants, equipment, and long-term bond holdings.
Liabilities
Liability accounts represent what the company owes to various creditors. This can include bank loans, taxes, rent due, and money owed for purchases made on credit. Examples of sub-accounts for liabilities include bank loans and taxes payable.
Equity
Equity accounts reflect the money that would remain if the company sold all of its assets and paid off all its liabilities. The remaining money belongs to the owners of the company or shareholders. Many sub-accounts in this category may only apply to larger companies, although some, such as retained earnings, can apply to small businesses and sole proprietorships. Some examples are stock and real estate.
Revenue
Revenue accounts record the income of the company and are reported on the income statement. Examples of revenue accounts include sales of goods or services, interest income, and investment income.
Expenses
Conversely, expense accounts reflect what the company needs to spend to conduct business. Some examples include rent for the physical office or offices, supplies, utilities, and salaries for all employees.
Please refer to the table below to remember how debits and credits work in various accounts. Remember that debits are always recorded on the left side and credits are always recorded on the right side.
| Account | Debit | Credit |
|---|---|---|
| Assets | Increase | Decrease |
| Liabilities | Increase | Decrease |
| Equity | Decrease | Increase |
| Revenue | Decrease | Increase |
| Expenses | Increase | Decrease |
How Do You Know if It’s a Debit or Credit in Accounting?
Accounting for small businesses can be confusing when it comes to debits and credits, as some accounts increase and/or decrease by different amounts depending on the transaction. Although there are complexities in every transaction, debit vs. credit can be simple if you remember the following:
Debit
More assets (like cash or utility accounts), fewer liabilities, and less equity
Credit = less assets, more liabilities, and more equity
Why should you use double-entry accounting?
Double-entry accounting allows for a more complete picture of your company compared to single-entry accounting. Single-entry accounting is a simple snapshot of just one transaction, aimed at showing only the annual net income. In contrast, double-entry accounting lets you see how complex transactions balance across many different aspects of your business, such as inventory, depreciation, sales, expenses, and more.
How do you determine debit and credit in accounting?
Although debits and credits behave differently in many accounts in your books, it is useful to remember that a debit is always recorded on the left side of the ledger, while a credit is always recorded on the right side. To determine whether you need to add a debit or credit to a specific account, consult your accountant.
Source: https://www.thebalancemoney.com/debit-vs-credit-whats-the-difference-5198321
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