Debit and Credit terms are used for bookkeeping and accounting purposes that are recorded in the accounting books of a business or company. The debit and credit transactions are entered in the journal entry book. A journal entry book helps businesses to keep the record. Debit and Credit are equal and opposite accounts where debit entries are placed on the left side and credit entries are placed on the right side.
Debit and credit are used in bookkeeping for maintaining a balance. If a debit entry incurs an increase in a debit account, then you will also have to post a credit entry that shows a decrease in the credit account.
Here is what we will cover:
- Difference between Debit and Credit
- How are Debits and Credits used?
- The Three Golden Rules of Accounting You Should Always Follow.
- How Debit and Credit Accounts are affected.
- Examples of Debit and Credit
- Why Debit and Credits are Important?
Difference between Debit and Credit:
- Debits record all the cash In-flows while Credits record all the cash Out-flows.
- A Debit entry increases an asset or expense account and decreases the equity or liability account, whereas a Credit entry increases an equity or liability account and decreases the asset or expense account.
- Entries are entered equally in both accounts but have opposite effects to each other. This happens to create balance in the record.
How are Debits and Credits used?
Debit and Credit are used in a double-entry bookkeeping system, where one transaction has an impact on two accounts at the same time. Transactions used in the Journal-entry book are further classified into five main accounts, described as follows:
- Asset Account:
Assets are the future economic gains for a company or business that it acquires.
Examples of Asset account entries:
- Account receivable
- Prepaid Expenses
- Property and Equipment
- Expense Account:
The expenses that incur on daily operations executed by the company/business.
Examples of Expense account entries:
- Liability Account:
Liabilities are what the company/business owes, such as loans, etc.
Examples of Liability account entries:
- Loans Payable
- Bank fees
- Accounts payable
- Income tax payable
- Revenue Account:
Revenue accounts are accounts related to income earned from the sale of products and services or interest from investments.
Examples of Revenue account entries include:
- Sales Revenue
- Service Revenue
- Interest Income
- Investment Income
- Equity Account:
The value of the company’s non-operational assets after liabilities have been paid off.
Examples of Equity account entries include:
- Mutual funds
- Real estate
- Retirement plans
- Liquid securities
- Debt Security
- Derivative Instruments
The Three Golden Rules of Accounting You Should Always Follow
You might have heard of the Golden Rule in life: Treat others as you want to be treated. But, did you know that there’s also a golden rule for accounting? In fact, there are three golden rules of accounting. And no … one of them is not treating your accounts the way they want to be treated.
If you want to keep your books up-to-date and accurate, follow the three basic rules of accounting.
3 Golden rules of accounting
It’s no secret that the world of accounting is run by credits and debits.
Debits and credits make a book’s world go ‘round.
Before we dive into the golden principles of accounting, you need to brush up on all things debit and credit as discussed above.
The golden rules of accounting also revolve around debits and credits. Take a look at the three main rules of accounting:
- Debit the receiver and credit the giver
- Debit what comes in and credit what goes out
- Debit expenses and losses, credit income and gains
1. Debit the receiver and credit the giver
The rule of debiting the receiver and crediting the giver comes into play with personal accounts. A personal account is a general ledger account pertaining to individuals or organizations.
If you receive something, debit the account. If you give something, credit the account.
Check out a couple of examples of this first golden rule below.
2. Debit what comes in and credit what goes out
For real accounts, use the second golden rule. A real account can be an asset account, a liability account, or an equity account.
Real accounts are also referred to as permanent accounts. Real accounts don’t close at year-end. Instead, their balances are carried over to the next accounting period.
With a real account, when something comes into your business (e.g., an asset), debit the account. When something goes out of your business, credit the account.
3. Debit expenses and losses, credit income and gains
The final golden rule of accounting deals with nominal accounts. A nominal account is an account that you close at the end of each accounting period. Nominal accounts are also called temporary accounts. Temporary or nominal accounts include revenue, expense, and gain and loss accounts.
With nominal accounts, debit the account if your business has an expense or loss. Credit the account if your business needs to record income or gain.
How Debit and Credit Accounts are affected:
|Account||Increased by||Decreased by|
Examples of Debit and Credit:
To understand better how transactions are entered in debit and credit accounts we will give some examples that may help you out.
A company sells its product to a client for $50 in cash. The entry for this transaction will be as follows:
|Sales Revenue $50|
We take another example to have a more clear view. A company buys equipment to increase its production capability from a wholesaler on the credit of $1,000. Now you would debit the equipment expense and credit the accounts payable in the liability account. With the help of a double-entry bookkeeping system, the company can easily monitor what it owes and what cash amount it has in hand.
Why Debit and Credits are Important?
The most important concept to understand when dealing with debits and credits is the total amount of debits must equal the total amount of credits in every transaction. It is vital to balance each transaction in double-entry accounting in order to have a clear and accurate general ledger, financial statements, and look into the financial health of your business.
It can take time to learn which accounts to debit and which to credit, and it becomes more complex and businesses grow and transactions accumulate.