DailyDime

Debits and credits record changes in your business accounts. A debit goes on the left. A credit goes on the right. Whether either one raises or lowers a balance depends on the account.

That is why paying rent creates a debit to an expense, while taking out a loan creates a credit to a liability. The words do not mean good or bad. They tell you how to record what happened.

Start with the reference below. Then follow a few transactions you might see in your own books.

How debits and credits work

Accountants use a T-account to show the two sides of one account. Debits sit on the left. Credits sit on the right. This graphic puts the rules for five account types in one place.

The plus and minus signs mean increase and decrease. Read across each row: a debit increases assets, while a credit decreases them. For liabilities, the rule flips.

Here is what each account type means:

• Assets: What the business owns or is owed, such as cash, inventory, equipment, and unpaid customer invoices.
• Expenses: Costs of running the business, such as rent, wages, and software.
• Liabilities: What the business owes, such as loans and unpaid supplier bills.
• Equity: The owners’ stake on the books. It equals assets minus liabilities. It is not the company’s market value.
• Revenue: What the business earns from selling products or services, before expenses.

Assets and expenses increase with debits. Liabilities, equity, and revenue increase with credits. Use the other side to reduce the balance.

The chart covers the main account types. Some accounts offset another account and follow the reverse pattern. For example, accumulated depreciation reduces the book value of equipment and normally has a credit balance.

Every entry must balance

A journal entry is the record of a transaction. In double-entry bookkeeping, it touches at least two accounts. Total debits must equal total credits, even when an entry has more than two lines.

The IRS guide to double-entry bookkeeping explains this balance between the two sides.

Suppose you pay $500 for this month’s software. You debit Software Expense $500 and credit Cash $500. The expense rises, cash falls, and both sides total $500.

Balanced does not always mean correct. If you record that software bill as rent, the entry still balances. The account choice is wrong.

Five examples from a normal week

These examples show the basic entries and leave out sales tax and payment fees. They assume revenue is recorded when earned and inventory stays on the balance sheet until sold.

You invest $10,000 in the business

• Debit Cash: $10,000.
• Credit Owner’s Equity or Contributed Capital: $10,000.

Cash rises because the business received money. Equity rises because the owner contributed it. The deposit is not revenue. If it were an owner loan, you would credit a loan payable account instead.

You buy $2,000 of inventory with cash

• Debit Inventory: $2,000.
• Credit Cash: $2,000.

One asset rises while another falls. Total assets stay the same at the time of purchase. In this example, the inventory becomes an expense when it is sold.

A customer pays $1,500 for work you just finished

• Debit Cash: $1,500.
• Credit Service Revenue: $1,500.

Cash and revenue both rise. This assumes you have not already recorded the sale.

If you recorded an unpaid invoice earlier, credit Accounts Receivable when the customer pays. That reduces what the customer owes. Crediting revenue again would count the same sale twice.

If the customer pays before you do the work, the payment generally goes to a liability called Unearned Revenue or Customer Deposits under accrual accounting. You record revenue as you earn it.

A lender sends you $20,000

• Debit Cash: $20,000.
• Credit Loan Payable: $20,000.

Cash rises, but so does the debt. Borrowing money does not create revenue or profit.

Later, a principal payment debits Loan Payable and credits Cash. Interest is separate from principal and must be recorded separately.

You pay $3,000 for this month’s rent

• Debit Rent Expense: $3,000.
• Credit Cash: $3,000.

Rent expense rises and cash falls. Paying the bill does not mean you credit the expense. Expenses increase with debits.

This assumes you have not already recorded the rent bill. If you did, the payment usually debits Accounts Payable instead. Do not record the expense twice.

A product sale also records the cost

Suppose you sell a product for $150 that cost you $60. If you track inventory as each sale happens, you record both the sale and the inventory leaving the business.

• Record the sale: debit Cash $150 and credit Sales Revenue $150.
• Record the cost: debit Cost of Goods Sold $60 and credit Inventory $60.

Revenue rises by $150. Cost of goods sold rises by $60. Gross profit from the sale is $90, before other business expenses.

The $60 was an asset while the product sat in inventory. Once sold, that cost becomes an expense. This is one reason buying inventory can reduce cash before it reduces profit.

Why your bank statement seems backward

When your bank credits your checking account, your cash goes up. Yet your business records that increase as a debit to Cash.

Both entries make sense because they describe different sets of books.

Your deposit is an asset to your business. To the bank, it is a liability because the bank owes you that money. The bank credits its liability when your balance rises. Your business debits its asset.

Read your accounting records from your business’s point of view. Your bank statement uses the bank’s point of view.

How to check an entry

Before choosing debit or credit, work through three questions:

1. Which accounts changed?
2. Did each account increase or decrease?
3. Which side of the chart records that change?

Then check that the debit and credit totals match.

Your bookkeeper or accounting software will handle most entries. Knowing the rules helps you spot a loan counted as revenue, a bill recorded twice, or inventory charged to the wrong account.

Keep the chart handy. Start with what changed, then use the account type to choose the side.