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A working knowledge of debits and credits pays off long after your first accounting class,
Most business owners picked up the basics of debits and credits at some point, whether in a business course or on the job. But it's easy for those fundamentals to get fuzzy once accounting software takes over the day-to-day recording. A quick refresher is worth the five (or fewer) minutes. Business owners who stay comfortable with debits and credits in accounting read their financial statements with more confidence, catch errors faster, and ask sharper questions of their bookkeeping team.
Start With The Accounting Equation
You likely remember the basic breakdown. As a refresher, every business tracks three categories:
- Assets: Items of value the business owns, such as cash, accounts receivable, inventory and equipment.
- Liabilities: Debts the business owes, including accounts payable, credit lines and loans.
- Owner's equity: What remains after subtracting liabilities from assets.
These three categories form the accounting equation: assets = liabilities + owner's equity. Every transaction a business records must keep this equation in balance, which is where debits and credits come in.
The Part That's Easy To Forget
In a traditional T-account, debits appear on the left and credits on the right. The detail that trips people up: neither one automatically means "increase" or "decrease." The effect depends on the type of account involved.
As a refresher:
- Increases in assets are recorded as debits; decreases are recorded as credits.
- Increases in liabilities and owner's equity are recorded as credits; decreases are recorded as debits.
- Revenue is generally recorded as a credit, which increases owner's equity.
- Expenses are generally recorded as debits, which decrease owner's equity.
Revenue and expense accounts don't stay on the books indefinitely. At the end of each accounting period, they close out to owner's equity and reset to zero for the next period.
For every transaction, total debits must equal total credits. That built-in check is part of what makes double-entry accounting such a reliable system for catching errors.
A Quick Example To Jog Your Memory
A short example brings the concept back into focus. Say an appliance repair shop fixes a washing machine for $500 and the customer pays cash on the spot. The bookkeeper would debit the cash account for $500, since the asset increased, and credit the revenue account for $500.
Now suppose the shop hires an independent contractor for the job and receives a $100 invoice for labor. That gets recorded as a $100 debit to contractor labor expense and a $100 credit to accounts payable, reflecting a new liability. Once the shop pays the invoice, the bookkeeper debits accounts payable for $100 and credits cash for $100, closing out the liability.
Real transactions often carry more moving parts. If the contractor had instead been an employee, the shop would need additional entries for wages, payroll taxes, and other payroll costs. If the repair required parts pulled from inventory, that would trigger its own set of entries too.
How This Feeds Your Financial Statements
Every debit and credit entry ultimately rolls up into three core financial statements:
- Balance sheet: Reports assets, liabilities, and owner's equity as of a specific date. These balances carry forward into the next period.
- Income statement: Shows revenue and expenses for the period. Unlike balance sheet accounts, these reset to zero once the period closes.
- Statement of cash flows: Breaks down cash sources and uses across operating, investing, and financing activities. Under U.S. Generally Accepted Accounting Principles, significant noncash investing and financing activities, such as acquiring equipment through financing, are disclosed separately rather than reported as cash flows.
Put The Refresher To Work
Knowing your debits from your credits is a good start, but accounting software still relies on accurate setup and sound judgment calls about how to classify each transaction. Contact GBQ's Client Accounting & Advisory Team with questions.
Frequently Asked Questions
What is a debit and credit in accounting?
A debit and credit in accounting are the two sides of every financial transaction recorded in a business's books. Debits and credits keep the accounting equation, assets equal liabilities plus owner's equity, in balance.
Do debits always mean a decrease?
No. Whether a debit or credit increases or decreases an account balance depends on the account type. Debits increase assets and expenses; credits increase liabilities, owner's equity, and revenue.
Why should business owners refresh their knowledge of debits and credits?
Even with automated accounting software, understanding debits and credits helps owners read financial statements accurately, catch data entry errors or misclassified expenses early, and have more productive conversations with their accounting team.
