Debits versus Credits
Grasping the difference between debits and credits goes a long way toward mastering bookkeeping basics. A debit increases an asset or expense account or decreases a liability or equity account. It goes in the left column. A credit increases a liability or equity account or decreases an asset or expense account. It goes in the right column.
Types of Accounts that Are Debits or Credits
For each business transaction created, there are entries for at least two accounts. A debit entry is posted to one account and a credit is posted to the other. Below, we cover the bookkeeping basics for how this works in balance sheet accounts and income statement accounts.
Balance Sheet Accounts
Here’s how the major balance sheet categories are impacted by this activity.
-Asset: Debit increase balances, but credits decrease balances.
-Liability: Debits decrease balances, but credits increase balances.
-Equity: Debits decrease balances, but credits increase the balances.
The double entry system supports the accounting equation, which governs all accounting transactions and accounting software.
Here is the equation: Assets = Liabilities + Equity
Income Statement Accounts
It’s equally important to be able to interpret how debits and credits impact income statement accounts. Otherwise, you won’t be able to read or produce the reporting required for your business.
-Revenue accounts. Debits decrease the balances, but credits increase the balances.
-Expense accounts. Debits increase the balances, but credits decrease the balances.
-Gain accounts. Debits decrease the balances, but credits increase the balances.
-Loss accounts. Debits increase the balances, but credits decrease the balances.
Why It’s So Important to Get It Right
The debits and credits for every business transaction recorded must be equal, or “in balance.” When there is a difference between total debits and total credits, this creates a discrepancy and the books are “out of balance.”
An out of balance system cannot be used to generate valid financial statements. Finding and correcting out of balance accounts takes a considerable amount of time and effort. Therefore, using debits and credits correctly in double-entry, or two-column accounting is the most important accounting control in ensuring accounting accuracy, and one of the essential tenets of bookkeeping basics.
For more information on how you can implement a professional to handle your business financials contact us today!
Enter your e-mail and subscribe to our newsletter