Debits and credits are an important part of organized bookkeeping. The two concepts work together so that bookkeepers can better manage their financial transactions. If you’re not accurately tracking your debits and credits, your accounting could get extremely messy and chaotic.
Some differences between the two can affect how your small business conducts its bookkeeping. Here is what you should know about debits and credits.
What are Debits and Credits?
Debit and credit are terms for transaction entries used in bookkeeping that track your business’s cash flow. You’ll use both terms when you use double-entry accounting.
Every transaction that your business makes is either a debit or a credit. Debits are money that comes out of your account, and credits are money that will go into your account.
What are the Rules of Debit and Credit?
Debits and credits have several rules for bookkeeping. Debits:
- Decrease liabilities and owner’s equity (on a balance sheet)
- Increase assets (on a balance sheet)
- Increase expense accounts (on an income statement)
- Decrease assets (on a balance sheet)
- Increase liabilities and owner’s equity (on a balance sheet)
- Increase revenue (on an income statement)
The essential bottom line is that for every transaction that your business makes, there must be at least one debit and one credit. If you don’t follow this rule, your books will turn out unbalanced.
In the accounting journal, you’ll write debits first on the left-hand side of your journal entry. You’ll also record your entries with debits first.
Next, you’ll record credits on the right-hand side of your journal entry. You’ll write credits below debits in the register. You’ll do this so you know where the money that you’ll spend will come from.
How Do Debits and Credits Work?
Debits and credits work whenever a transaction occurs. When one account decreases in value as a debit, the other account must increase in value as a credit.
In your chart of accounts, you’ll use these 5 categories to record your financial transactions:
- Owner’s equity
A list of how debits or credits work within the chart of accounts is below:
- Assets: Increase debit; Decrease credit
- Liabilities: Increase credit; Decrease debit
- Equity: Increase credit; Decrease debit
- Revenue: Increase credit, Decrease debit
- Expenses: Increase debit, increase credit
Examples of Debit and Credit
An example of both a debit and a credit can help illustrate the process. If your business spends $1,000 in office supplies purchased in cash, you’ll need to record both the item and how you purchased it.
Within the expense account of your small business’ income statement, you’ll provide:
- The date of the entry (on the left-most portion of the entry)
- The account name (the name you’ll record the transaction as)
- Debit (the amount paid for the office supplies)
- Credit (the amount used to purchase the office supplies)
Since cash is an asset, and assets increase credits, you’ll use the same $1,000 as both a debit and a credit. This will let you know that you’ll use the $1,000 in cash to purchase the office supplies.
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Debits and credits are the centerpieces of bookkeeping. Work with the pros today at 1-800Accountant for your bookkeeping needs.