Accounting 101: Understanding accounting debits & creditsLast updated on 03/22/2022
The accounting equation
The financial position of any company is calculated using the following terms:
Assets are things you own or rightfully belong to you. Examples of assets are cash, accounts receivable, inventory, buildings, and equipment. Assets have natural debit balances.
Liabilities are things you owe others. Examples of liabilities are accounts payable, deferred revenue, sales tax payable, and warranty liability. Liabilities have natural credit balances.
Owner’s or Stockholders’ equity is the difference between your assets and liabilities, or the value of the business. Equity can be raised capital (common stock), retained earnings (profits from prior periods), and additional paid in capital. Equity has a natural credit balance.
The accounting equation shows the relationship between these three items: Assets = Liabilities + Owner’s (or Stockholders’) Equity
Accounting is about having a balance between the two. Your company’s bookkeeping should ensure this equation is always balanced. The right side (assets) should always equal the left side (the sum of liabilities and equity).
Debits and credits
Transactions are events having a monetary impact on the financial statements of a business. Transactions are recorded in general ledger accounts by booking the record as a debit in one account and a credit in another. This is known as a “double-entry” system, because each transaction is recorded in at least two accounts. The balance from the Accounting Equation above is also true here, the entry must balance on both sides of the transaction record
Accountants commonly use T-accounts to easily visualize the effects of a transaction on an account. The graphic below shows T-accounts for common account types. It also shows how debits and credits will affect it.
Note: D means debit and C means credit. The Up Arrow indicates an increase to that account, while a Down Arrow indicates a decrease in the account.
As we can see in the graphic, debits are entered on the left side of the T-account. Debits will:
Increase an asset or expense account
Decrease a liability or equity account
We can also see that credits are entered on the right side of the T-account. Credits will:
Increase a liability or equity account
Decrease an asset or expense account
The Accounting Coach suggests these acronyms to help you remember these concepts:
Accounts increased by a debit (D E A L)
Accounts increased by a credit (G I R L S)
Stockholders' (Owner's) Equity
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