Accounting: Making Sense of Debits and Credits
Author: Patricia Lynn
Overview
Finally - debits and credits explained in an easy-to-understand way! Traditionally, the posting of debit and credit transactions has been called Bookkeeping. But the broader term, Accounting, is now commonly used to include the recording of financial transactions for a company. This tutorial will help you learn the difference between debits and credits, and will briefly explain the different account types that are used in a business accounting system; such as Assets and Liabilities.
There are many sample bookkeeping transactions included in the separate tutorial Super Sample Accounting Transactions.
Accounting Debits and Credits
Most accounting and bookkeeping software, such as Intuit QuickBooks or Sage Peachtree, is marketed as easy to use. But if you don't know some bookkeeping basics, you will make mistakes. If you never "kept books" manually, reading phrases such as “debits always go on the left, and credits always go on the right” brings no joy. We explain debits and credits in a new way - using basic math concepts!
You must understand that whenever you record an accounting transaction, one account is debited and another account is credited. And the amount of the debit must equal the amount of the credit. (This is called double-entry bookkeeping.)
From a math perspective, we can think of a debit as adding to an account, while a credit is subtracting from an account. (This is the opposite of what you may believe!) Keep in mind that in math, subtracting is the same thing as adding a negative number. Please note, however, than in QuickBooks, you NEVER enter a negative number. And another tidbit: accountants often use DR (debit record) to indicate a debit, and CR (credit record) to indicate a credit.
Debits and Credits: Change Your Paradigm
You may be confused because you thought a credit was a good thing! We learned these terms from dealing with banks and stores, but they were using the terms from their perspective. When the bank gave you a credit, it was their Cash they are crediting, or subtracting from. Good for you, not good for the bank. As a business owner you must think of debits and credits from your company’s standpoint. When you debit Cash, you add to it. When you credit Cash, you subtract from it.
Review of Positive and Negative
Do you remember the math number line from junior high? Zero is in the middle. The numbers to the right of zero are positive and they get bigger as they go to the right. The numbers to the left of zero are negative and they get bigger as they go to the left. If you add a positive number to any number on the number line, you move to the RIGHT on the number line to get your answer. Likewise, if you add a negative number (subtract) to any number on the number line, you always move to the LEFT on the number line to get your answer. Please see the examples below and use the number line above to help you. Don't move on until you understand this concept.
Whenever you DEBIT an account, or add a positive number to it, you move to the RIGHT on the number line. Examples:
- The balance in your checking account is $400. You debit the account $100 (you deposit $100). So, you add $100 to $400 and your checking account balance becomes $500. You went to the RIGHT on the number line because you debited the account.
- You owe your Dad $300. So you might say your account balance with him is -$300. You give your Dad $100 to pay down the loan. So you add $100 to -$300 and your account balance becomes -$200 ... you now owe your Dad $200. Because you debited the account, you went to the RIGHT on the number line.
And whenever you CREDIT an account, or add a negative number to it (subtract), you move to the LEFT on the number line. Examples:
- The balance in your checking account is $400. You credit the account $300 (you wrote a check for $300). So, you add -$300 to $400 and your checking account balance becomes $100. You went to the LEFT on the number line because you credited the account.
- You owe your Dad $300. You might say your account balance with him is -$300. You borrow another $100! So you add -$100 to -$300 and your account balance becomes -$400. Because you credited the account, you went to the LEFT on the number line.
[Remember: A debit adds a positive number and a credit adds a negative number. But you NEVER put a minus sign on a number you enter into QBP.]
Debit and Credit Accounts
In the examples above we looked at the Cash account and a Loan account. You many have noticed that the Cash account normally maintains a positive balance. Because of this, we would call Cash a positive account, or a Debit account.
Likewise, a Loan account normally maintains a negative balance in accounting and, because of this, we would call it a negative account, or Credit account. In accounting, some accounts will normally maintain a positive balance and some accounts will normally maintain a negative balance.
We said in the beginning that when you record an accounting transaction, one account is debited and another account is credited. Excluding Cash - which receives debits and credits, most accounts primarily receive debits (right on the number line), and other accounts primarily receive primarily credits (left on the number line).
The accounts that primarily receive debits maintain positive balances, and the accounts that primarily received credits tend to maintain negative balances.Why? If an account begins with a negative balance and only receives credits, that account’s balance will stay negative! And vice versa.
When we talk to others about the balance our of company's accounts, we ignore whether the balance is positive or negative in the underlying accounting system. We just mention the number portion without the sign. Let's say we have $300 in our loan account. In the accounting system, the value of the loan account is really negative $300. But we do not say "we have negative $300 in the Loan account." We just say that the Loan account has a balance of $300.
If we borrow another $100, then this $100 "credit" will move the balance on the number line to negative $400, but we'd just say we now have a loan balance of $400. When we talk about account balances, we ignore the sign. And when the accounting software prints the Balance Sheet and Profit and Loss reports, it also ignores the sign.
The Five types of Accounts in an Accounting System:
To fully understand how to record debit and credit transactions, we must understand that all of our accounts fit into one of 5 categories. They account categories are:
- Assets: what the company owns of value (Cash, Accounts Receivable, furniture, vehicles)
- Liabilities: what the company owes to others (loans, Accounts Payable)
- Equity: the company’s net worth. Equity equals Assets minus Liabilities
- Revenue: money the company is earning
- Expenses: money the company is spending
Assets and Expenses
Two of the 5 accounts maintain a positive balance. They are Assets and Expenses. Because they maintain a positive balance, they are called debit accounts. You will read this in Accounting books: “Accounts that normally have a positive balance are increased with a Debit and decreased with a Credit.” Of course they are! Look at the number line. If you add a positive number (debit) to a positive number, you get a bigger positive number. But if you start with a positive number and add a negative number to it (credit), you will get a smaller positive number (you are moving left on the number line). A quick note about the Asset account called Cash. This account does get both debits (you deposit money) and credits (you write checks); but its goal is to maintain a positive balance!
Liabilities, Equity, and Revenue
The other 3 types of accounts primarily receive credits, so naturally they tend to maintain a negative balance. They are Liabilities, Equity, and Revenue. They are called credit accounts. You will read this in Accounting books: “Accounts that normally maintain a negative balance are increased with a Credit and decreased with a Debit.” Again, look at the number line. If you add a negative number (credit) to a negative number, you get a larger negative number! (you’ve moved to the left on the number line). But if you start with a negative number and add a positive number to it (debit), you get a smaller negative number because you’ve moved to the right on the number line.
Some of you might be thinking: if I start off with -$200 and add $600 to it, I get $400 - a positive number. In accounting, balances never - or shouldn't - cross over zero. A negative account might eventually reach zero - such as a loan account when the loan has finally been paid off. When you debit this loan account each month with your payment, the negative balance gets smaller and smaller until it reaches zero with your final payment. But credit accounts seldom have a positive balance, and debit accounts seldom have a negative balance.
[Remember: A debit adds a positive number and a credit adds a negative number. But you NEVER put a minus sign on a number you enter into QBP.]
Debit and Credit Accounts Logic
There is logic behind which accounts maintain a negative balance. It makes sense that the liability accounts maintain a negative balance because they track company debt. But what about Equity and Revenue? Again, you need to look at it from the company’s viewpoint. Having lots of Revenue is good for you - the business owner. But from the company’s viewpoint, the money being tracked by Equity and Revenue accounts is money the company owes you - the owner.
What about the accounts that maintain a positive balance? It’s easy to understand why an Asset account is positive since it tracks your company’s Cash and other valuable possessions. But what about Expenses? Well, the services and supplies required to run the business do cause a decrease in owner’s equity, so they could be looked upon as positive from the company’s standpoint.
Debit and Credit Wrap-Up
If you fully understand the above, you will find it much easier to determine which accounts need to be debited or credited in your transactions. The good news is that QuickBooks helps you when it comes to Cash! When you make a deposit, QuickBooks automatically debits Cash so you just need to indicate which account should receive the credit. And when you write a check, QuickBooks automatically credits Cash (takes money out of the account) and you just need to indicate which account should receive the debit (perhaps an expense account).
You can look for yourself in QuickBooks and see which accounts are debit accounts and which are credit accounts. Right-click on an account and click Find. On the next window, click Find. You will then see all the postings done to that account from the beginning. Do not be confused, however. When you look at the Balance Sheet, you’ll see that it lists the negative balances without a negative sign, and subtracts the positive balances in order to calculate its totals.
Once in a while, a debit or credit may be split and posted against multiple accounts. For example, you might credit Cash $100 to make a loan payment, but then debit a Loan account $95 and a debit an Interest Expense account $5. But the total amount of the credit must always equal the total amount of the debit.
[Remember: A debit adds a positive number and a credit adds a negative number. But you NEVER put a minus sign on a number you enter into QBP.]
Please link to this tutorial using the following HTML:
<a href="http://www.keynotesupport.com/accounting-basics-debits-credits.shtml">Making Sense of Debits and Credits</a>
Don't miss our related tutorials
► Super Sample Accounting Transactions
► Using Items and COGS
Disclaimer: Keynote Support is providing general information in a highly readable format as a service to the visitor. We have made every effort to provide accurate information, but the reader cannot infer from this article that Keynote Support is providing financial advice. Please consult with your financial advisor.
