How to Understand Debits and Credits

In double entry bookkeeping, transactions are recorded in two accounts. These accounts are called debits and credits — where debits are on the left side of the chart, and credits are on the right. These debits and credits constitute a double-entry bookkeeping system in which every single business transaction is recorded in at least two separate accounts.

In bookkeeping, debits and credits mean very different things but are often misunderstood by people who are not familiar with accounting and finances. Today let’s help you how to understand debits and credits.

Debits and credits track account values and the changes in these values. For a journal entry in the account ledger (where every business transaction is recorded) to be considered valid, the total debits in a transaction must equal to the total credits. These entries record changes in value which are a result of business transactions.

What Is a Double Entry System?

There are two sides to every single transaction. Double entry bookkeeping states that each financial transaction must have an equal and opposite effect in at least two separate accounts.

Therefore, a debit to an account must always be accompanied by a credit to another account. This satisfies the following accounting equation:

Assets = Liabilities + Equity.

A double entry system chart has two accounts: debits and credits. These accounts include rent, vendors, loans, utilities, payroll and more.

Understanding Debits and Credits

So What Is a Debit, Exactly?

A debit is a type of accounting entry which increases an expense or asset account and decreases liability or equity. It is positioned on the left side of an accounting entry and represents an addition of an expense or asset, or a decrease in revenue. Examples of debits include wages, office supplies, and rent.

What Is a Credit?

A credit is considered an increase of liability or equity, and a decrease in an expense or asset account. It implies a negative amount on an account. For example, a credit is recorded for a certain product or service that is given to a debtor, and payment of this credit is expected in an agreed upon period of time.

Balancing the Books

For the books to balance, all debits in a transaction must equal the credits. Remember: debits increase assets and expenses while decreasing liability or equity.

Credits do the opposite: decrease assets and expenses and increase liability and equity.

This means that if one account is debited, the opposite account needs to be credited. When there is a transaction, a minimum of two accounts will always be affected.

Knowing how to understand debits and credits allow a business owner to understand the financial health of his or her company, allowing them to know just exactly how much cash is available and owed at a single time.