Please Note: This article is part of a series of articles titled Accounting and Bookkeeping Principles for Contractors
Written by James R. Leichter
Debits and Credits
There is a lot of confusion among contractors regarding debits and credits. A thorough understanding of these terms is very important to accounting and being a good bookkeeper. Knowing what they do will help bookkeepers figure our common accounting problems.
Debit and credit are an example of technical accounting terms that differ from their meaning in everyday language. At the bank, a debit means a decrease and a credit means an increase. In accounting, the terms can have opposite meanings:
Credit: An entry on the right side of the T-Account.
Debit: An entry on the left side of the T-Account.
Each item in a Balance Sheet is considered an account that is subject to increases, or additions, and decreases, or subtractions. A T-Account illustrates how increases or decreases to an account are recorded.
In the case of the Cash account in the Balance Sheet sample transactions on page 5, increases to Cash are recorded on the left side of the T-Account because cash itself is an asset that is recorded on the left side of a Balance Sheet. Decreases to Cash are recorded on the right side of the T-Account. The four sample transactions result in the following T-Account.
The amount in the Cash account after the transactions have been entered is its balance. The balance is the difference between the increases and decreases in the T-Account. The balance in the above case is $13,000 ($20,000 – $7,000). In T-Accounts, the dollar symbol ($) is not shown because all amounts are in dollars.
Debit and Credit Rules
In accounting, the results of a debit or credit depend on the type of account being acted upon. As illustrated above, a debit or addition or increase to an asset account means adding an amount on the left-hand side and a credit or subtraction or decrease to an asset account means adding an amount on the right-hand side. The rules are reversed for liability or equity accounts that are normally entered into the right column of a Balance Sheet. Since debits are always entered on the left side and credits are always entered on the right side of a T-Account, only the meaning of the entry changes: A debit is now a subtraction or decrease to a liability or equity account and a credit is now an addition or increase to a liability or equity account.
Revenue and expense accounts are temporary accounts whose purpose are to illustrate increases or decreases in equity. Revenue is the increase in equity that results from business operations and expense is the decrease in equity that results from business operations. The difference between revenue and expenses for an accounting period, or changes in equity, is called income, profit, or earnings. For more information about income, see The Income Statement.
Revenue and expense accounts follow the debit and credit rules for equity accounts: Revenues are credits that increase equity and expenses are debits that decrease equity. Credits are always recorded on the right side of the T-Account and debits are always recorded on the left side of the T-Account.
In accordance with the concept of double entry and the fundamental accounting equation, assets must always equal liabilities and equities. It follows, then, that debits must always equal credits. The relationship between debits and credits and assets, liabilities, and equities can be illustrated by the following example:
In the first Balance Sheet example transaction on page 5, an asset account and an equity account were both increased by $20,000. Cash was debited (cash increased) and Paid-in Capital was credited (equity increased). Therefore, debits equaled credits.
Accounts are always increased on the side of the Balance Sheet that they are normally entered. Since assets are entered on the left side of the Balance Sheet, a debit or entry to the left side of an asset account increases its balance. Since liabilities and equities are entered on the right side, a credit or entry to the right side of a liability or equity account increases its balance. The reverse for debiting assets, liabilities, and equities is also true. Overall:
- To increase an asset account, debit it
- To decrease an asset account, credit it
- To increase a liability or equity account, credit it
- To decrease a liability or equity account, debit it
- To record revenues, credit a revenue account
- To record expenses, debit an expense account.
Debit and credit rules apply for all types of accounts except contra accounts. See Accumulated Depreciation for more information.
Notes about Debits and Credits
In accounting, the customary format for entering debits and credits follows these rules:
- The debit portion of the entry appears first with the amount in the left-hand column.
- The credit portion is indented on the next line with the amount in the right-hand column.
- There is no exception to the rule that debits must equal credits
- Debit is often abbreviated as “Dr.” and credit as “Cr.”
- Credits increase income, liability, and fund accounts and reduce asset and expense accounts
- Debits increase expense and asset accounts and reduce income and liability accounts
- When recording expense transaction, the word “charge” is often used in place of the word “debit.”
Please read the article The Income Statement next.