All business transactions have a monetary impact on the financial statements and the bottom line of an organization. When accounting for these transactions, a company records the numbers in two accounts, a debit column on the left and a credit column on the right. The use of a 2-column transaction recording format is the most essential of all controls over accounting accuracy.
Debits are accounting entries that either increase an asset or expense account or decrease a liability or equity account. Credits are accounting entries that either increase a liability or equity account or decrease an asset or expense account.
Why do Credits and Debits matter?
Every accounting transaction has a debit entry and a credit entry. There is no maximum limit to the number of accounts involved in a transaction, but there must be at least two (one debit and one credit). The totals of the deficit credits must always equal each other so that the accounting transaction is “in balance.” If the transaction is not balanced, it would be impossible to create financial statements.
The meaning of a debit or credit can at times be confusing. For instance, if a company “debits” a cash account, the amount of cash on hand actually increases. But if it debits an accounts payable account, it means the amount of the AP liability decreases. That’s because credits and debits have different impacts across various types of accounts:In asset accounts, a debit increases the balance and a credit decreases the balance. For liability accounts, debits decrease, and credits increase the balance. In equity accounts, a debit decreases the balance and a credit increases the balance.
The reason for this disparity is that the underlying accounting equation is that assets equal liabilities plus equity. So, a company may only “have” assets if they were paid for with liabilities or equity. There are additional rules for accounts that appear on an income statement:
- Revenue and gain accounts, where a debit decreases and a credit increases the balance.
- Expense and loss accounts, where a debit increases the balance and a credit decreases the balance.
One way to lessen the confusion is to always remember that debits appear in the left accounting column and credits always go in the right column. There are no exceptions.
The most common debits and credit in accounting transactions are:
- Sale for cash
- Sale on credit
- Received cash in payment of an account receivable
- Purchased supplies from a supplier for cash
- Purchased supplies from a supplier on credit
- Purchased inventory from a supplier for cash
- Purchase inventory from a supplier on credit
- Paid employees
- Take out a loan
- Repay a loan