Published on April 6th, 2023.

Debits vs. Credits

Debits and credits make up the double-entry system, in which every transaction involves the two accounting entries. Debits (DR) correspond to the left side of the general ledger and generally record the money flowing into the business. On the other hand, credits (CR) correspond to the right side of the general ledger and generally record the money flowing out of the business.

The Effects of Debits & Credits on Various Accounts

Before learning the effects of debits and credits on the seven types of accounts that all business transactions can be classified, it is crucial to understand each account type.

• An asset account reflects the value of resources owned by a company and is expected to provide future economic benefit. Some assets include cash, accounts receivable and inventory.
• A liability account represents the amount of money a company owes to others. Some liability accounts include accounts payable and notes payable.
• The expense account represents the costs incurred by the firm for conducting business and generating revenue. Some expense accounts include cost of goods sold (COGS), wages, rent, and advertising.
• An equity account displays the investments by shareholders in the company. Some equity accounts include common stock, contributed surplus, and retained earnings.
• A revenue account reflects the amount of money generated from operating and non-operating activities. 
• A gain account reflects an increase in value from activities not related to the core business.
• A loss account reflects a decrease in value from activities not related to the core business.

Debits

• Increases assets, expenses, and losses.
• Decreases liabilities, equities, revenue, and gains.

Credits

• Increases liabilities, equities, revenue, and gains.
• Decreases assets, expenses, and losses.

Understanding Debits & Credits

To better understand the concept of debits and credits, let’s take a look at an example. Suppose Anna purchased $500 worth of inventory for her business from the manufacturer and paid in cash. As a result of this transaction, Anna’s cash decreased by $500, while her inventory value increased by $500. Since both cash and inventory are asset accounts, a decrease in cash results in a credit entry and an increase in inventory results in a debit entry. Therefore, the journal entry for this transaction would look like a debit to inventory and a credit to cash.

Let’s take a look at another example that affects two different types of account. Suppose this time Anna purchased $1,200 worth of inventory for her business on account from the manufacturer. A purchase on account indicates that Anna did not pay with cash but on credit and will have to pay back the manufacturer at a later time. As a result, Anna owes the manufacturer $1,200 and thus, a credit of $1,200 will be entered in accounts payable.

The Double-Entry Accounting System

As mentioned previously, every transaction under the double-entry system involves a debit and a credit, where the sum of all debits must equal the sum of all credits. Thus, this system tracks the movement of a company’s money. Since a debit and a credit entry is always affected, the double-entry system satisfies the fundamental accounting equation, which states that Assets = Liabilities + Shareholder’s Equity.

Putting Your Knowledge to the Test

With a general understanding of debits, credits and the double-entry accounting system, do you think you can record the journal entries for the following transactions?

1. Peter’s Plumbing Services sold $2,300 worth of equipment for cash.
2. Michael borrowed $600 cash from the bank to start his meat shop business.
3. Lily’s Library purchased $3,700 worth of books from Bob’s Bookstore and paid $1,200 in cash, with the rest on credit.

Sources:

Accounting 101: Debits and Credits 

Debits VS Credits: A Simple, Visual Guide 

Double Entry: What It Means in Accounting and How It's Used