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What’s the Difference Between Debits and Credits in Accounting?

Welcome to part 1 of 3 in this “Accounting Crunch” series. In this series, we’ll be covering debits & credits, double-entry accounting and T-accounts. Each part will consist of one topic. In this part, we’ll be covering debits and credits!

In this article, we’ll be covering what debits and credits are, how they differ and how they’re used in accounting.

So, 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 value of the account will be modified in a different way.

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. When you credit a liability, equity or revenue account, you increase its value.

As you can see, there are some subtleties to this!

To understand them, let’s look at those different types of accounts in more detail. Without the knowledge of accounts, we can’t understand what debits and credits are and how they’re used.

In these articles, we’ll be talking about the balance sheet and the profit and loss report. If you’re not familiar with them, I suggest taking a look at our beginner’s guide to the balance sheet and beginner’s guide to the profit and loss statement.

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 report.

  • Assets – Asset accounts represent the value of items that the business owns. These items could either be tangible or intangible. It could be anything from patents to coffee beans.
  • Liability – Liability accounts show money that your business owes. This could be from loans, or from delaying paying for goods or services (accounts payable).
  • 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’ve covered the basics, we’re 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.

What this means is, if you were to debit an account, another account will be credited for the exact same amount. This keeps your accounts balanced.

See our article Why Does a Balance Sheet Need to Balance? for why that’s important! 

Debits

A debit is an action which 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. 

Credits

A credit is an action which 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. 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.

Debit
Credit
Asset
+
Liability
+
Equity
+
Revenue
+
Expense
+

A plus sign shows that the account will increase when being credited/debited. A 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, another account will always be credited.

Debits & credits, double-entry accounting and T-accounts

Over the next two parts, we’ll be going through double-entry accounting and T-accounts.

When a company performs a transaction, one side of an account will always be debited, whilst another account will always be credited, hence the name “double-entry”. We’ll cover double-entry bookkeeping in part 2.

A T-account is a visual way of displaying a transaction. It shows which accounts are being debited, and which are being credited. The reason it’s called a T-account is simply that it is shaped like a T. We’ll cover this in part 3.

In preparation for part 2 (double-entry accounting), I suggest reading our article on why does a balance sheet need to balance.

Cal Corcoran 11th June 2020 By
 

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