In this post, we will look at debits and credits, their definitions, how they differ, and their usage in accounting.
What is the difference between debits and credits?
Debits and credits are both ways of changing the value of an account in a general ledger. Depending on the type of account you debit or credit, the account’s value will be modified differently.
Impact of Debit and Credit on different accounts
By debiting an asset or expense account you increase its value
By debiting a liability, equity, or revenue account you decrease its value.
By crediting an asset or expense account, you reduce its value.
By crediting a liability, equity, or revenue account, you increase its value.
As you can see, there are some subtleties to this!
To understand them better, let us look at those different types of accounts in more detail. Without the knowledge of some accounting conventions, we cannot understand what debits and credits are and how they are used.
Let us look at the balance sheet also known as the statement of financial and business position and condition and the Income Statement which is also known as the Profit and Loss report.
What are accounts in accounting?
Accounts are records which show the movement of value around the business. There are five categories that accounts can fall under.
Asset, liability, and equity accounts are reported in the balance sheet whilst revenue and expense accounts are reported in the profit and loss account.
- Assets – Asset accounts represent the value of items that the business owns which could either be tangible or intangible. It could be anything building, inventory, etc.
- Liability – Liability accounts show money that your business owes. This could be from loans, or from delaying paying for goods or services (accounts payable).
- Owners Equity – Equity accounts represent how much of the business is owned by the owner or shareholders.
- Revenue – Revenue accounts track the value of money earned by providing services or selling products.
- Expense – Expense accounts track the value of money spent on the purchase of goods or services.
These can be split into additional sub-accounts for more detailed classifications of the various transactions businesses undertake.
All company accounts are recorded in its general ledger. The general ledger is essentially the home for all the business’s accounts and the transactions that they show.
Now we have covered the basics, we are going to go through how debits and credits affect accounts.
What are debits and credits?
Debits and credits are terms in accountancy used to record transactions between accounts.
They refer to the movement of value between accounts. These movements can be presented on the balance sheet and profit and loss statement. Debits and credits go hand in hand.
Basically, if you were to debit an account then another account will be credited for the exact same amount. This keeps your accounts balanced.
A debit is an action that increases the value of your business or increases its expenses. For example, a fixed asset account is debited when the business purchases a new vehicle. The account has increased in value.
Debits are the movement of value into assets and expense accounts, whilst moving value out of liability, equity and revenue accounts.
By debiting asset or expense accounts, you are increasing the value of these accounts.
By debiting liability, equity, or revenue accounts, you are reducing the value of these accounts.
A credit is an action that reduces the value of your business or increases revenue accounts. For example, a current asset account is credited when cash leaves the business. The account has decreased in value.
Credits increase liability, equity, and revenue accounts, whilst reducing asset and expense accounts.
By crediting liability, equity, or expense accounts, you are increasing the value of these accounts.
By crediting asset or expense accounts, you are reducing the value of these accounts.
What are the differences between debits and credits?
When you debit an asset or expense account, you increase its value, however, when you debit a liability, equity or revenue account, you decrease its value.
When you credit an asset or expense account you reduce its value but when you credit a liability, equity, or revenue account, you increase its value.
A good way to think about credits and debits is to use a table like the one below.
A plus sign shows that the account will increase when being credited/debited while minus sign shows that the account will be reduced when being credited/debited.
Debits and credits are intertwined and will always be found together. If one account of a transaction is debited, then another account will always be credited.
This will lead us to an accounting concept called Double-entry Accounting or Bookkeeping. I will be discussing this concept in my next post.
Conclusively, I hope we have learned something about the differences between Debits and Credits and how they impact the main five accounting journals.
Thank you and remember to like, share and comment.
Written by Hay-R-Hay