What are debits and credits?
Debit and Credit are the respective sides of an account.
Debit refers to the left side of an account.
Credit refers to the right side of an account.
Explanation
In accounting, every account or statement (e.g. accounting ledger, trial balance, profit and loss account, balance sheet) has 2 sides known as debit and credit.
In a typical accounting ledger (often referred to as a T-Account) the debit and credit sides are split horizontally as shown below:
| XYZ Receivable A/C | |||
|---|---|---|---|
|
|
|
||
|
Sales |
$12,500 |
Discount allowed |
$500 |
|
|
|
Bank |
$12,000 |
|
|
$12,500 |
|
$12,500 |
|
|
|
||
Debit sideAccording to the dual aspect principle, each accounting entry is recorded in 2 equal debit and credit portions. In other words, the total amount that will be recorded in the left side (debit) of accounting ledgers will always equal to the total amount recorded on the right side (credit).
For example, you may consider how the accounting entries have been recorded in the Receivable A/C shown above.
The ledger has been debited on account of credit sales amounting $12,500 and (as can be ascertained from the particulars) the same amount has been credited in the Sales A/C. Similarly, the credit entries in the Receivable A/C relating to discount allowed and bank receipts are matched with equal amounts recorded on the debit sides of Discount Allowed A/C and Bank A/C respectively.
In case of any confusion, please refer Accounting for Sales section for more thorough explanation of the accounting entries discussed above.
Now the question arises, how do we know what to record on the debit side of an account and what to record on the credit side?
Accounting has specific rules regarding what should be debited and what should be credited as summarized in the chart below:
| Debit Entries account for: | Credit Entries account for: |
|---|---|
|
Increase in assets |
Decrease in assets |
|
Increase in expenses |
Decrease in expenses |
|
Decrease in liabilities |
Increase in liabilities |
|
Decrease in income |
Increase in income |
|
Decrease in equity |
Increase in equity |
Assets, expenses, liabilities, income & equity are the 5 elements of financial statements. For explanation and examples of the various elements, please refer elements of financial statements section.
As with accounting ledgers, all accounting statements are based on the rules of debit and credit. For example, in a balance sheet, assets are reported on the debit side whereas liabilities and equity are presented on the credit side. Although traditional accounts and statements are presented in a T-Account format as above (which makes understanding debits and credits a bit easier for beginners) many accounts and statements nowadays are reported in a vertical format.
But fear not! As long as you master the rules of debit and credit, you shall have no problem in understanding their application and presentation.
Example
Record the debit and credit entries of the following transactions:
a) Purchase of an office building for $1 million via funds transfer
b) Bonus payable to various employees amounting $5 million
c) Credit Sales during the period amounting $7 million
d) Issuance of ordinary shares at par for $10 million
a) Purchase of an office building
| Account | $ | Effect | |
|---|---|---|---|
|
Debit |
Office Building |
1,000,000 |
Increase in Asset |
|
Credit |
Bank |
1,000,000 |
Decrease in Assets |
b) Performance Bonus
| Account | $ | Effect | |
|---|---|---|---|
|
Debit |
Salaries, wages and benefits |
5,000,000 |
Increase in Expense |
|
Credit |
Bonus Payable |
5,000,000 |
Increase in Liabilities |
c) Credit Sales
| Account | $ | Effect | |
|---|---|---|---|
|
Debit |
Accounts Receivables |
7,000,000 |
Increase in Asset |
|
Credit |
Sales Revenue |
7,000,000 |
Increase in Income |
d) Issuance of ordinary shares
| Account | $ | Effect | |
|---|---|---|---|
|
Debit |
Bank |
10,000,000 |
Increase in Asset |
|
Credit |
Share Capital |
10,000,000 |
Increase in Equity |
If you face any problem in understanding the double entries, please refer double entry accounting section.