When analyzing a business transaction, one of the first steps is deciding if the accounts involved increase or decrease. However, in accounting, we do not use the term "increase or decrease". We use more appropriate words “debit” and “credit” instead.
In accounting, debit means the receiving account while credit is the giving account. Nevertheless, the meaning of debit and credit often change depending on the type of account. Debit simply means the left side of account while credit means right side of account. Don't forget the accounting equation: ASSETS = LIABILITIES + EQUITY.
The accounting equation must always be in balance and the rules of debit and credit enforce this balance.
When we record business transactions, the total amount of debits must equal the total amount of credits. For example: When we debit one account (or accounts) for $100, we must credit another account (or accounts) for the same amount. The accounting requirement which states that each transaction be recorded by an entry that has equal debits and credits is called double-entry procedure, or dual concept of accounting. Watch this video to help you remember this concept:
Review this quick important guide to recording debits and credits in accounting. Before you proceed, It will be of great importance for you to understand the rules for debits and credits.
Note: The rules above are general guidelines and there are exceptions to these rules.
After we have recognized a business event as a business transaction, we analyze it to determine its increase or decrease effects on the assets, liabilities, stockholders’ equity items, dividends, revenues, or expenses of the business. Then we classify these increase or decrease into debits and credits.
How To Record Changes in Balance Sheet Accounts
Balance Sheet accounts are classified as assets, liabilities and equity. It will be easier record transactions into journal entries when you focus on the equal sign in the accounting equation. Assets are usually on the left of the equal sign, increase on the left side or DEBIT side. Liabilities and stockholders’ equity are on the right of the equal sign, increase on the right or CREDIT side.
Assets Liabilities & Equity
DEBIT increases CREDIT increases
CREDIT decreases DEBIT decreases
There is an exception to the rules above: Dividends (or withdrawals for a non-corporation) is an equity account but it decreases the equity since the owner is taking equity from the company. This is called a contra-account because it doesn't work the way the account normally works. For Dividends, it would be an equity account but have a normal DEBIT balance. This means that debit will increase and credit will decrease.
Recording changes in Income Statement Accounts
The net income of a business is added to the equity. Net income is calculated as revenues less expenses and it is derived from the income statement or profit and loss account. Below are the recording rules for revenues and expenses:
CREDIT increases DEBIT increases
DEBIT decreases CREDIT decreases
The logic behind this rule is that revenues increase retained earnings, and increases in retained earnings are recorded on the right side. Expenses reduce retained earnings, and reduces in retained earnings are recorded on the left side.
The side of the account that increases (debit or credit) is referred to as an account’s normal balance. Don't forget that any account can have both debits and credits. Below is an illustration of each account type and the normal balances they will have.
Account Type Normal Balance
A journal entry will always have AT least one debit and one credit irrespective of what elements are present in the business transaction.