Debit Vs Credit

Accounting: Making Sense of Debits and Credits

Finally! Accounting debits and credits explained in an easy-to-understand way! This beginner's tutorial helps you learn the difference between debits and credits, and provides guidelines and rules for knowing when to debit or credit an account.

Overview

Traditionally, the posting of debit and credit transactions has been called Bookkeeping. But the broader term, Accounting, is now commonly used to include the recording of financial transactions for a company. For help with the most common transactions a small business might enter into an accounting program, see our popular tutorial Super Sample Accounting Transactions.

Accounting Debits and Credits

Most accounting and bookkeeping software, such as Intuit QuickBooks or Sage Peachtree, is marketed as easy to use. But if you don't know some bookkeeping basics, you will make mistakes. If you never "kept books" manually, reading a phrase such as “debits always go on the left and credits always go on the right” brings no joy. We explain debits and credits in a new way - using basic math concepts!

You must understand that whenever you record an accounting transaction, one account is debited and another account is credited.  And the amount of the debit must equal the amount of the credit. This is called double-entry bookkeeping.

From a math perspective, think of a debit as adding to an account, while a credit is subtracting from an account. (This is the opposite of what you may believe!) Keep in mind that in math, subtracting is the same thing as adding a negative number. Please note, however, than in accounting programs such as Intuit QuickBooks or Sage Peachtree Accounting, you do not enter negative numbers. And another little fact you should know: accountants and bookkeepers often use DR (debit record) to indicate a debit, and CR (credit record) to indicate a credit.

Debits and Credits: Change Your Paradigm

You may be confused because you thought a credit was a good thing! We learned these terms from dealing with banks and stores, but they use these terms from their perspective. When the bank gives you a credit, it is their Cash they are crediting, or subtracting from. That is good for you, but not good for the bank. As a business owner you must think of debits and credits from your company’s standpoint. When you debit Cash, you add to it. When you credit Cash, you subtract from it.

Review of Positive and Negative

Do you remember the math number line from school? Zero is in the middle. The numbers to the right of zero are positive and they get bigger as they go to the right. The numbers to the left of zero are negative and they get bigger as they go to the left. If you add a positive number to any number on the number line, you move to the RIGHT on the number line to get your answer. Likewise, if you add a negative number (subtract) to any number on the number line, you always move to the LEFT on the number line to get your answer. Please see the examples below and use the number line above to help you. Don't move on until you understand this concept.

Whenever you DEBIT an account, or add a positive number to it, you move to the RIGHT on the number line. Examples:

1. The balance in your checking account, or Cash, is $400. You deposit $100, which results in a debit of $100. The balance is now $500. You move to the RIGHT on the number line because you debit the account.
2. You owe your Dad $300, so you might say your account balance is -$300. You give your Dad $100, which results in a debit of $100. Your balance is now -$200. You move to the RIGHT on the number line because you debit the account.

And whenever you CREDIT an account, or add a negative number to it (subtract), you move to the LEFT on the number line. Examples:

1. The balance in your checking account is $400. You write a check for $300, which results in a credit of $300. The balance is now $100. You move to the LEFT on the number line because you credit the account.
2. You owe your Dad $300, so you might say your account balance is -$300. You borrow another $100, which results in a credit to the loan account. Your balance is now -$400. You move to the LEFT on the number line because you credit the account.

[Remember: A debit adds a positive number and a credit adds a negative number. But you NEVER put a minus sign on a numbers you enter into the accounting software.]

Debit and Credit Accounts

We said in the beginning that every transaction results in a debit to one account and a credit of equal value to another account. In accounting, most accounts either primarily receive debits or primarily receives credits.

In the examples above we looked at the Cash (checking) account and a Loan account. You many have noticed that the Cash account normally maintains a positive balance. Accounts that normally maintain a positive balance are called positive accounts orDebit accounts, and they normally receive debits.

Likewise, a Loan account normally maintains a negative balance. Accounts tat normally maintain a negative balance are callednegative accounts or Credit accounts, and they normally receive credits.

When we discuss our company's account balances, we ignore whether the actual balance in the underlying accounting system is positive or negative. We just discuss the number portion without the sign. If we have a $300 loan, the value of the loan account in the accounting system is really negative $300, but we just say our loan account balance is $300.

When the accounting software prints the Balance Sheet and Profit and Loss reports, it also ignores the sign.

The Five types of Accounts in an Accounting System:

To fully understand how to record bookkeeping transactions, we must understand that all of our accounts fit into one of 5 categories. The account categories are:

• Assets: what the company owns of value (Cash, Accounts Receivable, furniture, vehicles)
• Liabilities: what the company owes to others (loans, Accounts Payable)
• Equity: the company’s net worth. Equity equals Assets minus Liabilities
• Revenue: money the company is earning
• Expenses: money the company is spending

Assets and Expenses

Because Asset and Expense accounts maintain positive balances, they are positive, or debit accounts. Accounting books will say “Accounts that normally have a positive balance are increased with a Debit and decreased with a Credit.” Of course they are! Look at the number line. If you add a positive number (debit) to a positive number, you get a bigger positive number. But if you start with a positive number and add a negative number (credit), you get a smaller positive number (you move left on the number line). The asset account called Cash, or the checking account, is unique in that it routinely receives debits and credits, but its goal is to maintain a positive balance!

Liabilities, Equity, and Revenue

Liability, Equity, and Revenue accounts usually receive credits, so they maintain negative balances. They are called credit accounts. Accounting books will say “Accounts that normally maintain a negative balance are increased with a Credit and decreased with a Debit.” Again, look at the number line. If you add a negative number (credit) to a negative number, you get a larger negative number! (moving left on the number line). But if you start with a negative number and add a positive number to it (debit), you get a smaller negative number because you move to the right on the number line.

We have not discussed crossing zero on the number line. If we have $100 in our checking account and write a check for $150, the check will bounce and Cash will have a negative value - an undesirable event. A negative account might reach zero - such as a loan account when the final payment is posted. And many accounts, such as Expense accounts, are reset to zero at the beginning of the new fiscal year. But credit accounts rarely have a positive balance and debit accounts rarely have a negative balance at any time.

[Remember: A debit adds a positive number and a credit adds a negative number. But you NEVER put a minus sign on a numbers you enter into the accounting software.]

Debit and Credit Accounts Logic

There is logic behind which accounts maintain a negative balance. It makes sense that Liability accounts maintain negative balances because they track debt, but what about Equity and Revenue? Well, though we are happy if our Revenue and Equity accounts have healthy balances, from the company’s viewpoint, the money in these accounts is money that the company owes to its owners.

What about debit accounts? It’s easy to understand why an Asset account is positive since it tracks the company’s Cash and other valuable possessions, but what about Expenses? Well, the services and supplies required to run the business do cause a decrease in Owner’s Equity, so they could be viewed positively from the company’s standpoint.

Debit and Credit Wrap-Up

If you fully understand the above, you will find it much easier to determine which accounts need to be debited and credited in your transactions. Modern accounting software helps us when it comes to Cash. When you enter a deposit, most software such as QuickBooks automatically debits Cash so you just need to choose which account should receive the credit. And when writing a check, the software automatically credits Cash, so you just need to select the account to receive the debit (perhaps an Expense account).

You can see which accounts are debit accounts and credit accounts in QuickBooks. Right-click on an account and click Find. On the next window, click Find. You will then see all the postings done to that account.

A debit or credit may be split among multiple accounts. For example, when making a $100 loan payment, Cash would receive a $100 credit. But two debits may be required: a $5 debit to an Interest Expense Account, and a $95 debit to the Loan Account.

[Remember: A debit adds a positive number and a credit adds a negative number. But you NEVER put a minus sign on a numbers you enter into the accounting software.]

We hope this article has been helpful. Cheers!