Business and Personal Finance: Debits and Credits

The Basic Accounts – Debits and Credits

One of the most basic—and most confusing—concepts of accounting is debits and credits. That is usually one of the first things taught, and one of the later things that clicks, in basic accounting courses. The debit-credit scheme, though, is at the bottom of every accounting system. Once you have a grasp on how debits and credits work, you will understand much more easily how the whole system works.

Every single accounting transaction has a debit side and a credit side, and the two have to be equal. The word “side” here is crucial: in old-fashioned, traditional manual accounting systems (where each account looks like a T), all debits go on the left and all credits go on the right.

Here’s the tricky part. Some accounts are increased by debits; some are decreased. In the same way, some accounts are increased by credits, and others are decreased. Whether a debit acts like an addition or subtraction completely depends on the type of account you are working with. Check out the following table to see which accounts work in which ways.

Account Type AssetDebitCredit
AssetIncreaseDecrease
LiabilityDecreaseIncrease
EquityDecreaseIncrease
RevenueDecreaseIncrease
ExpenseIncreaseDecrease

Sometimes It’s the Opposite

There are some accounts that act completely the opposite of the other accounts in their group. For example, there are asset accounts with normal credit balances, and sales accounts with normal debit balances. These special accounts are called contra accounts, because they act contrary to the norm.

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Although contra accounts may seem puzzling, they serve a very clear purpose. They can help you separate certain kinds of transactions from their “parent” account, giving you a clearer picture of what’s really going on. Sometimes that breakdown is very important and can impact your future business strategies and policies.

For example, suppose your company sells sweaters. Most of those sales will be final, but there are bound to be some returns. If you just lumped those returns into your sales account, sort of like negative sales, you would have no way of knowing later on how much you sold altogether and how much was returned. Instead, you would just see one lower sales number with no breakdown. For planning purposes, though, it’s important to know what percentage of your sweater sales resulted in returns. An expected percentage might not cause you to take action, but a much higher percentage probably would.

Breaking Down a Transaction

As you’ve already learned, every transaction has both a debit and a credit component. That does not mean that it has a plus and a minus (although that may happen sometimes), or that one account balance will go up while another goes down (which may also happen). It means that there will be a left-side impact and a right-side impact. How those affect the accounts involved depends wholly on what kind of accounts they are.

For example, suppose you write a check to pay the company’s electric bill. That transaction would result in a debit to electricity expense and a credit to cash. Your electricity expense is increased, and cash decreased. If you change that transaction a little, the account impact changes, too. Suppose you paid that electric bill with a credit card; you would still debit electricity expense, but now the credit would go to credit card payable, a liability account. In that case, the expense account increases, and so does the liability account (because now you owe more).

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A month later, you pay that credit card bill. That transaction includes a debit to credit card payable and a credit to cash. Credit card payable, the liability account, gets decreased with a debit (the payment reduced your balance). The cash account, an asset, is decreased as well, but this account is decreased with a credit entry.