Debits and credits Bookkeeping
Thursday, December 20, 2018

Debits and credits Bookkeeping


Bean Counter’s Accounting and Bookkeeping “Cheat Sheet”

Provided by: Bean Counter

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Source Documents

( Invoices, Checks, etc.)


Journals -Transactions first recorded using Debits and Credits

General Ledger -Summarized transactions posted to the General Ledger Accounts using Debits and Credits


Abbreviated Accounting Equation

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Property =

Property Rights

Expanded Accounting Equation

Assets =

Liabilities +

Owner’s Equity
 
Balance Sheet Accounts

Permanent Accounts

Types Of Accounts

Asset Accounts =

Liability Accounts +

Capital Accounts (Mom)

Increase/Decrease Columns

Increase

Decrease

Decrease


Increase


Decrease

Increase

Account -Left / Right Side Columns

Left Side

Right Side

Left Side


Right Side


Left Side

Right Side

Debit / Credit Columns

Debit

Credit

Debit

Credit


Debit

Credit

Owner’s Equity Equation that illustrates the effect of closing the temporary accounts -revenue-expenses-draws to the permanent
Equity Accounts.

Owner’s Equity = Beginning Capital + Profit or – Loss – Owners Draws + Owner’s Investments
 
Income Statement Accounts

Accounts Closed To Capital Account at End Of Period

Temporary (Nominal) Accounts

“Mom” Equity’s “Kids” – Revenue – Expense – Draws

Expenses

Draws

Revenue

Effect On “Mom” Equity (Capital)

Decreases

Increases

Revenue , Expense, and Draw Account “Rules”

These accounts are often referred to as temporary or nominal accounts
because at the end of a year (period) they are closed and their balances are transferred to
a permanent Equity (Capital) Account (Balance Sheet Account).

Debit / Credit Columns


Increase

Decrease

Decrease

Increase

Left Side

Right Side

Left Side

Right Side


Debit


Credit

Debit


Credit


Profit / Loss Equation

Profit / Loss = Revenue – Costs and Expenses

Note: Bold highlighted items in my cheat sheet represent the Normal Type Of Balance For an Account – Debit or Credit

The purpose of my cheat sheet is to serve as an aid for those needing help in determining how to record the debits and credits
for a transaction.

My “Cheat Sheet” Table begins by illustrating that source documents such as sales invoices and checks are analyzed and then
recorded in Journals using debits and credits.
These Journals are then summarized and the debit and credit balances are Posted (transferred)
to the General Ledger Accounts and the amounts are posted
to the left side of the general ledger accounts for debit balances and to the
right side of the general ledger accounts for credit balances.
The General Ledger Accounts are made up of Balance Sheet and Income Statement Accounts.

At the end of a year (period), the revenue and
expenses accounts (Ma’s Kids) are set to zero and their balances are transferred to a permanent equity account
in the Balance
Sheet such as Owner’s Capital (Mom) or Retained Earnings.
This process is what is known as Closing The Books. Since the balances of these accounts
are set to zero (closed out) at the end of a period, these accounts are sometimes referred to as temporary or nominal accounts.
After closing the books for a year, the only accounts that have a balance are the Balance Sheet Accounts.
That’s why the Balance Sheet Accounts are also referred to as Permanent Accounts.

Of course my cheat sheet is based on the Accounting Equation ( Assets = Liabilities + Owner’s Equity ) which must be kept in balance and
double-entry accounting, where for every debit to an account there must be an equal credit to another account.

Account Definition

An Account is a separate record for each type
of asset, liability, equity, revenue, and expense
used to show the beginning balance
and to record the increases and decreases for a period and the
resulting ending balance at the end of a period.

You should be aware that
All Accounts:

  • Can Be Debited and Credited

  • Have an Increase Side and a Decrease Side

  • Have a Debit Side and a Credit Side

        Debit Side is the Left Side (Left Column)

        Credit Side is the Right Side (Right Column)

  • Have a Normal Balance Amount that is normally a Debit Balance or a Credit Balance

  • Have a Type and are classified as an Asset, Liability, Equity, Revenue, Expense, or Draw

  • Are Either a Balance Sheet or Income Statement Account

    Major Types of Accounts

    Assets

    Formal Definition:The properties used in the operation or investment activities of a business.

    Informal Definition:All the good stuff a business has (anything with value). The goodies.

    Additional Explanation:
    The good stuff includes tangible and intangible stuff. Tangible stuff you
    can physical see and touch such as vehicles, equipment and buildings.
    Intangible stuff is like pieces of
    paper (sales invoices) representing loans to your customers where they
    promise to pay you later for your services or product.
    Examples of assets that many individuals have are cars, houses, boats,
    furniture, TV’s, and appliances. Some examples of business type
    assets are cash, accounts receivable, notes receivable, inventory,
    land, and equipment.

    Liabilities

    Formal Definition:Claims by creditors to the property (assets) of a business until they are paid.

    Informal Definition:Other’s claims to the business’s good stuff. Amounts the business owes to others.

    Additional Explanation:
    Usually one of a business’s biggest liabilities
    (hopefully they are not past due) is to suppliers where
    a business has bought goods and services and charged them. This is similar to us going out
    and buying a TV and charging it on our credit card. Our credit card bill is a liability.
    Another good personal example is a home mortgage.
    Very few people actually own their own
    home. The bank has a claim against the home which is called a mortgage. This mortgage
    is another example of a personal liability. Some examples
    of business liabilities are accounts payable, notes payable, and
    mortgages payable.

    Owner’s Equity also called Owner’s Capital

    Comment:Both terms may be used interchangeably. In my tutorial lessons, I may refer to both terms
    or just use one or the other.

    Formal Definition:The owner’s rights to the property (assets) of the business;
    also called proprietorship and net worth.

    Informal Definition:What the business owes the owner. The good stuff left for the owner assuming all
    liabilities (amounts owed) have been paid.

    Additional Explanation:Owner’s Equity (Capital) represents the owner’s claim
    to the good stuff (assets). Most people are familiar
    with the term equity because it is so often used with lenders wanting
    to loan individuals money based on their home equity.
    Home equity can be thought of as the amount of money an owner would receive if he/she
    sold their house and paid off any mortgage (loan) on the property.

    Revenue (Income), Expenses, Investment, and Draws

    Revenues, expenses, investment, and draws are sub categories of owner’s equity (capital).
    Think of owner’s equity as a mom named Capital with four children to
    keep up with (I know she’s only got one clinging to her leg but
    she left Expense, Investment, and Draws at home). The kids are named Revenue, Expense, Investment, and Draws and each kid
    has one job that they are responsible for in order to earn their allowance.
    Kid Revenue is responsible for keeping track of increases in owner’s equity (Ma Capital)
    and Kid Expense is responsible for keeping track of decreases in owner’s equity (Ma Capital)
    resulting from business operations.
    Kid Draws has the job of keeping up with decreases
    in owner’s equity (Ma Capital) resulting from owner withdrawals for
    living expenses and other personal expenses.
    Kid Investment has the job of keeping up with increases
    in owner’s equity (Ma Capital) resulting from additional amounts invested in the business.

    Revenue also called Income

    Formal Definition:The gross increase in owner’s equity (capital) resulting from
    the operations
    and other activities of the business.

    Informal Definition:Amounts a business earns by selling services and products.
    Amounts billed to customers for services and/or products.

    Additional Explanation:Individuals can best relate by thinking
    of revenue as their earnings/wages they receive from their job.
    Most business revenue results from selling their products and/or
    services.

    Expense also called Cost

    Formal Definition:Decrease in owner’s equity (capital) resulting from the cost of goods, fixed assets, and services and supplies consumed in the operations of a business.

    Informal Definition:The costs of doing business.
    The stuff we used and had to pay for or charge to run our business.

    Additional Explanation:Some examples of personal expenses that most individuals
    are familiar with are utilities, phone, clothing, food, gasoline, and repairs.
    Some examples of business expenses are office supplies, salaries & wages,
    advertising, building rental, and utilities.

    Owner’s Investments

    Formal Definition:
    Increase in owner’s equity (capital) resulting from additional investments of cash and/or other property made by the owner.

    Informal definition:
    Additional amounts, either cash or other property, that the owner puts in his business.

    Additional Explanation:Although these amounts can be kept up with as a separate item,
    they are usually recorded directly in the Owner’s Capital Account.
    In other words, immediately put into Ma Equity’s purse.

    Owner’s Drawing

    Formal Definition:
    Decrease in owner’s equity (capital) resulting from withdrawals made by the owner.

    Informal definition:
    Amounts the owner withdraws from his business for living and personal expenses.

    Additional Explanation:The owner of a sole proprietorship does not normally
    receive a “formal” pay check from the business, but just like most of the rest of us needs
    money to pay for his house, car, utilities, and groceries. An owner’s draw is
    used in order for the owner to receive money or other “goodies” from his
    business to take care of his personal bills.

    Definitions of Debits and Credits

    Debit

  • An entry in the financial books of a firm that increases an asset
    or an expense or an entry that decreases a liability, owner’s equity (capital)
    or income.
  • Also, an entry entered on the left side (column) of a journal or general ledger account.
  • Let’s combine the two above definitions into one complete definition.

    An entry (amount) entered on the left side (column) of a journal or general ledger account
    that increases an asset, draw
    or an expense or an entry that decreases a liability, owner’s equity (capital)
    or revenue.

  • Credit

  • An entry in the financial
    books of a firm that increases a liability, owner’s equity (capital) or revenue,
    or an entry that decreases an asset or an expense.

  • Also, an entry entered on the right side (column) of a journal or general ledger account.

  • Let’s combine the two above definitions into one complete definition.

    An entry (amount) entered on the right side (column) of a journal or general ledger account
    that increases a liability, owner’s equity (capital) or revenue,
    or an entry that decreases an asset, draw, or an expense.

    The term debit refers to the left side of an account and credit refers to the right side of an account.
    A debit is always entered in the left hand column of a Journal or Ledger Account and a credit
    is always entered in the right hand column.
    Debit is abbreviated Dr. and Credit is abbreviated Cr.

    When you post (record) an entry in the left hand column of an account you are debiting that account.
    Whether the debit is an increase or decrease depends on the type of account.
    Likewise, when
    you post (record) an entry in the right hand column of an account you are crediting that account.
    Whether the credit is an increase or decrease depends on the type of account.

    How To Use and Apply The Debit and Credit Rules:

    (1) Determine the types of accounts the transactions affect-asset, liability, revenue, expense
    or draw account.

    (2) Determine if the transaction increases or decreases the account’s balance.

    (3) Apply the debit and credit rules based on the type of account and whether the balance of
    the account will increase or decrease.

    Our Simple Debit / Credit Rule:

    • All Accounts that Normally Have a Debit Balance are Increased with a Debit by
      placing the amount in the Left Column of the account and Decreased with a Credit by
      placing the amount in the Right Column of the account.

      • Assets

      • Draws

      • Expenses
    • All Accounts that Normally have a Credit Balance are Increased with a Credit by
      placing the amount in the Right Column of the account and Decreased with a Debit by placing the
      amount in the Left Column of the account.

      • Liabilities

      • Owner’s Equity ( Capital )

      • Revenue


    All You Need To Know About Debits and Credits

    Summarized In One Sentence
    :

    Enter an amount in the Normal Balance Side of an Account to Increase the Balance of an Account and
    in the Opposite Side of an Account to Decrease the Balance of an Account.

    Additional Clarification:

    Since Assets, Draw, and Expense Accounts normally have a Debit Balance, in
    order to Increase the Balance of an Asset, Draw, or Expense Account enter the amount in the Debit or Left Side Column and in order
    to Decrease the Balance enter the amount in the Credit or Right Side Column.

    Likewise, since Liabilities, Owner’s Equity (Capital),
    and Revenue Accounts normally have a Credit Balance in order to Increase the Balance
    of a Liability, Owner’s Equity, or Revenue Account the amount would be entered in the Credit or
    Right Side Column and the amount would be entered in the Debit or Left Side
    column to Decrease the Account’s Balance.

    The Debit and Credit Rules Presented as A Table


    Account Type

    Normal Balance

    Increase To Account Balance

    Decrease To Account Balance

    Account Example

    Property Accounts

    Asset

    Debit

    Debit – Left Column Of Account

    Credit – Right Column Of Account

    Cash, Accounts Receivable

    Property Rights Accounts

    Liability

    Credit

    Credit – Right Column Of Account

    Debit – Left Column Of Account

    Accounts Payable

    Owner’s Equity

    Credit

    Credit – Right Column Of Account

    Debit – Left Column Of Account

    Owner’s Capital

    Revenue

    Credit

    Credit – Right Column Of Account

    Debit – Left Column Of Account

    Sales

    Costs and Expenses

    Debit

    Debit – Left Column Of Account

    Credit – Right Column Of Account

    Rent, Utilities, Advertising

    Owner Draws

    Debit

    Debit – Left Column Of Account

    Credit – Right Column Of Account

    Owner Draws

    Typical Types Of Business Transactions

    and the Debits and Credits
    and Accounts Used To Record Them

    In a typical business transaction we get something and we give up something.

    Sale-Sell goods and/or services

    • (1) Cash Sale-customer pays at the time of sale

      The business gets cash or a
      check from their customer and gives up a product or service
      to their customer.

      Accounts Used:

      Debit: Cash   

      Credit: Sales

    • (2) On Account Sale-business allows the customer time to pay

      The business gets a promise to pay from their customer
      and gives up a product or service
      to their customer.

      Accounts Used:

      Debit: Accounts Receivable   

      Credit: Sales

    Purchase goods and/or services

    • (3) Cash Purchase-business pays the supplier at the time of purchase

      The business gets a product or service
      from their supplier and gives up cash or a check
      to their supplier.

      Accounts Used:

      Debit: Expense or Inventory Account   

      Credit: Cash

    • (4) On Account Purchase-supplier allows the business time to pay

      The business gets a product or service from a supplier and
      gives up a promise
      to pay to their supplier.

      Accounts Used:

      Debit: Expense or Inventory Account   

      Credit: Accounts Payable

    (5) Pay Supplier Charge Purchases
    -pay suppliers
    for products and/or services
    that we promised to
    pay for later (charge).

    The business gets the amount of
    their promise to pay the supplier reduced
    and gives
    up cash or a check.

    Accounts Used:

    Debit: Accounts Payable   

    Credit: Cash

    (6) Receive Customer Charge Payments
    -receive payments from a customer that promised to pay us later (charge sale).

    The business gets cash or a check from their customer
    and gives up (reduces the amount of) their customer’s promise to pay.

    Accounts Used:

    Debit: Cash   

    Credit: Accounts Receivable

    (7) Borrow Money (Loans)
    The business gets cash or equipment
    and gives up a promise to pay.

    Accounts Used:

    Debit: Cash or Equipment   

    Credit: Note Payable

    (8) Repay a Loan

    The business gets the amount of their
    promise to pay reduced and gives up cash or a check.

    Accounts Used:

    Debit: Note Payable   

    Credit: Cash

    (9) Draw

    The business gets the owner’s claim to the business assets reduced
    and gives up cash or a check.


    Accounts Used:


    Debit: Owner’s Draw   

    Credit: Cash

    (10) Payroll (not covered in this tutorial)

    The business gets services from
    their employees and gives up a check.

    Accounts Used:

    Debit: Salary & Wages Expense   

    Credit: Cash


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  • Debits and credits

    From Wikipedia, the free encyclopedia

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    For the Rudyard Kipling collection, see Debits and Credits (book) .
    “Debit” redirects here. It is not to be confused with Debt . For other uses, see Debit (disambiguation) .
    Part of a series on
    Accounting
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    In double entry bookkeeping , debits and credits (abbreviated Dr and Cr, respectively) are entries made in account ledgers to record changes in value resulting from business transactions. Generally speaking (in T-Account terms), if cash is spent in a business transaction, the cash account is credited (that is, an entry is made on the right side of the T-Account’s ledger), and conversely, when cash is obtained in a business transaction, it is described as a debit (that is, an entry is made on the left side of the T-Account’s ledger). Debits and Credits can occur in any account. For simplicity it is often best to view Debits as positive numbers and Credits as negative numbers. When all the debits and credits that are transacted in each account are added up the resulting account total could be a net Debit (positive number) or a net Credit (negative number). If the total of the account is in a net Debit position (positive), it is generally classified in the Asset section of the balance sheet, whereas accounts that total to a net Credit (negative) are shown in the liability section of the balance sheet. Accounts that relate to the company’s profit (example: Sales, Cost of Sales, Expenses) are totaled to yield company earnings and are classified in the Equity section of the balance sheet. A net Credit (negative) balance in Retained Earnings in the Equity Section demonstrates that the company has been profitable over time, whereas a Debit (positive) balance in the Equity section, would demonstrate that the company has been unprofitable. In most companies the following accounts end-up in Credit positions: accounts payable, share capital, loans payable; while Debit accounts typically include Equipment, Inventory, Accounts Receivable. Debits (positive numbers) must equal Credits (negatives) in each transaction; individual transactions may require multiple debit and credit entries. [1] [2]

    For the company as a whole, the net position of every account (debit or credit) is shown in the trial balance report. The trial balance report must add to zero; otherwise an error has occurred.[ citation needed ]

    Accountants group accounts from the trial balance report to prepare financial statements.[ citation needed ]

    Contents

    • 1 History
    • 2 Aspects of transactions
    • 3 Commercial understanding
    • 4 Terminology
      • 4.1 Debit cards and credit cards
      • 4.2 General ledgers
    • 5 The five accounting elements
    • 6 Principle
      • 6.1 Accounts pertaining to the five accounting elements
        • 6.1.1 Asset accounts
        • 6.1.2 Liability accounts
        • 6.1.3 Equity accounts
        • 6.1.4 Income/revenue accounts
        • 6.1.5 Expense accounts
      • 6.2 Example
      • 6.3 Further examples
    • 7 T-accounts
    • 8 Contra account
    • 9 Real, personal, and nominal accounts
    • 10 References
    • 11 External links

    History[ edit ]

    The first known recorded use of the terms is Venetian Luca Pacioli ‘s 1494 work, Summa de Arithmetica, Geometria, Proportioni et Proportionalita (translated: Everything That Is Known About Arithmetic, Geometry, Proportions and Proportionality). Pacioli devoted one section of his book to documenting and describing the double-entry bookkeeping system in use during the Renaissance by Venetian merchants, traders and bankers. This system is still the fundamental system in use by modern bookkeepers. [3] Indian merchants had developed a double-entry bookkeeping system, called bahi-khata, predating Pacioli’s work by at least many centuries, [4] and which was likely a direct precursor of the European adaptation. [5]

    One theory is that in its original Latin, Pacioli’s Summa used the Latin words debere (to owe) and credere (to entrust) to describe the two sides of a closed accounting transaction. Assets were owed to the owner and the owners’ equity was entrusted to the company. At the time negative numbers were not in use. When his work was translated, the Latin words debere and credere became the English debit and credit. Under this theory, the abbreviations Dr (for debit) and Cr (for credit) derive from the original Latin. [6] However, Sherman [7] casts doubt on this idea because Pacioli uses Per (Latin for “from”) for the debtor and A (Latin for “to”) for the creditor in the Journal entries. Sherman goes on to say that the earliest text he found that actually uses “Dr.” as an abbreviation in this context was an English text, the third edition (1633) of Ralph Handson’s book Analysis or Resolution of Merchant Accompts [8] and that Handson uses Dr. as an abbreviation for the English word “debtor.” (Sherman could not locate a first edition, but speculates that it too used Dr. for debtor.) The words actually used by Pacioli for the left and right sides of the Ledger are “in dare” and “in havere” (give and receive). [9] Geijsbeek the translator suggests in the preface:

    ‘if we today would abolish the use of the words debit and credit in the ledger and substitute the ancient terms of “shall give” and “shall have” or “shall receive”, the personification of accounts in the proper way would not be difficult and, with it, bookkeeping would become more intelligent to the proprietor, the layman and the student.’ [10]

    As Jackson has noted, “debtor” need not be a person, but can be an abstract operator (cf. “divisor” in math):

    “…it became the practice to extend the meanings of the terms … beyond their original personal connotation and apply them to inanimate objects and abstract conceptions…” [11]

    Aspects of transactions[ edit ]

    To determine whether one must debit or credit a specific account we use either the accounting equation approach which consists of five accounting rules [12] or the traditional approach based on three rules (for Real accounts, Personal accounts, and Nominal accounts) to determine whether to debit or to credit an account. [13]

    • Real accounts are the assets of a firm, which may be tangible (machinery, buildings etc.) or intangible (goodwill, patents etc.)
    • Personal accounts relate to individuals, companies, creditors, banks etc.
    • Nominal accounts relate to expenses, losses, incomes or gains.

    Whether a debit increases or decreases an account depends on what kind of account it is. For instance, an increase in an asset account is a debit. An increase in a liability or an equity account is a credit.

     Kind of accountDebitCredit
    AssetIncreaseDecrease
    LiabilityDecreaseIncrease
    Income/RevenueDecreaseIncrease
    Expense/Cost/DividendIncreaseDecrease
    Equity/CapitalDecreaseIncrease

    The complete system is very easy to remember if you focus on Assets, Expenses, Costs, Dividends (highlighted in chart). All those account types increase with debits or left side entries. Conversely, a decrease to any of those accounts is a credit or right side entry. On the other hand, increases in revenue, liability or equity accounts are credits or right side entries, and decreases are left side entries or debits.

    Debits and credits occur simultaneously in every financial transaction in double-entry bookkeeping. In the accounting equation, Assets = Liabilities + Equity, so, if an asset account increases (a debit (left)), then either another asset account must decrease (a credit (right)), or a liability or equity account must increase (a credit (right)). Note also that in the extended equation, revenues increase equity and expenses, costs & dividends decrease equity, so their difference is the impact on the equation.

    For example, if a company provides a service to a customer who does not pay immediately, the company records an increase in assets, Accounts Receivable with a debit entry, and an increase in Revenue, with a credit entry. When the company receives the cash from the customer, two accounts again change on the company side, the cash account is debited (increased) and the Accounts Receivable account is now decreased (credited). When the cash is deposited to the bank account, two things also change, on the bank side: the bank records an increase in its cash account (debit) and records an increase in its liability to the customer by recording a credit in the customer’s account (which is not cash). Note that, technically, the deposit is not a decrease in the cash (asset) of the company and should not be recorded as such. It is just a transfer to a proper bank account of record in the company’s books, not affecting the ledger.

    To make it more clear, the bank views the transaction from a different perspective but follows the same rules: the bank’s vault cash (asset) increases, which is a debit; the increase in the customer’s account balance (liability from the bank’s perspective) is a credit. A customer’s periodic bank statement generally shows transactions from the bank’s perspective, with cash deposits characterized as credits (liabilities) and withdrawals as debits (reductions in liabilities) in depositor’s accounts. In the company’s books the exact opposite entries should be recorded to account for the same cash. This concept is important since this is why so many people misunderstand what debit/credit really means.

    In summary, debits are simply transaction entries on the left-hand side of ledger accounts, and credits are entries on the right-hand side.

    Commercial understanding[ edit ]

    This section does not cite any sources . Please help improve this section by adding citations to reliable sources . Unsourced material may be challenged and removed . (October 2014) ( Learn how and when to remove this template message )

    When setting up the accounting for a new business, a number of accounts are established to record all business transactions that are expected to occur. Typical accounts that relate to almost every business are: Cash, Accounts Receivable, Inventory, Accounts Payable and Retained Earnings. Each account can be broken down further, to provide additional detail as necessary. For example: Accounts Receivable can be broken down to show each customer that owes the company money. In simplistic terms, if Bob, Dave, and Roger owe the company money, the Accounts Receivable account will contain a separate account for Bob, and Dave and Roger. All 3 of these accounts would be added together and shown as a single number (i.e. total ‘Accounts Receivable’ – balance owed) on the balance sheet. All accounts for a company are grouped together and summarized on the balance sheet in 3 sections which are: Assets, Liabilities and Equity.

    All accounts must first be classified as one of the five types of accounts (accounting elements) ( asset , liability , equity , income and expense ). To determine how to classify an account into one of the five elements, the definitions of the five account types must be fully understood. The definition of an asset according to IFRS is as follows, “An asset is a resource controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity”. [14] In simplistic terms, this means that Assets are accounts viewed as having a future value to the company (ie. cash, accounts receivable, equipment, computers). Liabilities, conversely, would include items that are obligations of the company (i.e. loans, accounts payable, mortgages, debts).

    The Equity section of the balance sheet typically shows the value of any outstanding shares that have been issued by the company as well as its earnings. All Income and expense accounts are summarize in the Equity Section in one line on the balance sheet called called Retained Earnings. This account, in general, reflects the cumulative profit (retained earnings) or loss (retained deficit) of the company.

    The Profit and Loss Statement is an expansion of the Retained Earnings Account. It breaks-out all the Income and expense accounts that were summarized in Retained Earnings. The Profit and Loss report is important in that it shows the detail of sales, cost of sales, expenses and ultimately the profit of the company. Most companies rely heavily on the profit and loss report and review it regularly to enable strategic decision making.

    Terminology[ edit ]

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    The words debit and credit can sometimes be confusing because they depend on the point of view from which a transaction is observed. In accounting terms, assets are recorded on the left-hand side (debit) of asset accounts, because they are typically shown on the left-hand side of the accounting equation (A=L+SE). Likewise, an increase in liabilities and shareholder’s equity are recorded on the right-hand side (credit) of those accounts, thus they also maintain the balance of the accounting equation. In other words, if “assets are increased with left-hand entries, the accounting equation is balanced only if increases in liabilities and shareholder’s equity are recorded on the opposite or right-hand side. Conversely, decreases in assets are recorded on the right-hand side of asset accounts, and decreases in liabilities and equities are recorded on the left-hand side”. Similar is the case with revenues and expenses, what increases shareholder’s equity is recorded as credit because they are in the right side of equation and vice versa. [15] Typically, when reviewing the financial statements of a business, Assets are Debits and Liabilities and Equity are Credits. For example, when two companies transact with one another say Company A buys something from Company B then Company A will record a decrease in cash (a Credit), and Company B will record an increase in cash (a Debit). The same transaction is recorded from two different perspectives.

    This use of the terms can be counter-intuitive to people unfamiliar with bookkeeping concepts, who may always view a credit as an increase and a debit as a decrease. This is because most people typically only see bank accounts and billing statements (e.g., from a utility ). A depositor’s bank account is actually a Liability to the bank, because the bank holds money which legally belongs to the depositor, so that the bank owes the money to the depositor. Thus, when the customer deposits money into the account, the bank credits the account (increases the bank’s liability). At the same time, the bank adds the money to its own cash holdings account. Since the latter account is an Asset, the increase is a debit. But the customer typically does not see this side of the transaction.

    On the other hand, when a utility customer pays a bill or the utility corrects an overcharge, the customer’s account is credited. This is because the customer’s account is one of the utility’s accounts receivable , which are Assets to the utility because they represent money the utility can expect to receive from the customer in the future. Credits actually decrease Assets (the utility is now owed less money). If the credit is due to a bill payment, then the utility will add the money to its own cash account, which is a debit because the account is another Asset. Again, the customer views the credit as an increase in the customer’s own money and does not see the other side of the transaction.

    The simplest most effective way to understand Debits and Credits is by actually recording them as positive and negative numbers directly on the balance sheet. If you receive $100 cash, put $100 (debit/Positive) next to the Cash account. If you spend $100 cash, put -$100 (credit/Negative) next to the cash account. The next step would be to balance that transaction with the opposite sign so that your balance sheet adds to zero. The way of doing these placements are simply a matter of understanding where the money came from and where it goes in the specific account types (like Liability and net assets account). So if $100 Cash came in and you Debited/Positive next to the Cash Account, then the next step is to determine where the -$100 is classified. If you got it as a loan then the -$100 would be recorded next to the Loan Account. If you received the $100 because you sold something then the $-100 would be recorded next to the Retained Earnings Account. If everything is viewed in terms of the balance sheet, at a very high level, then picking the accounts to make you balance sheet add to zero is the picture.

    At the end of any financial period (say at the end of the quarter or the year), the net debit or credit amount is referred to as the accounts balance. If the sum of the debit side is greater than the sum of the credit side, then the account has a “debit balance”. If the sum of the credit side is greater, then the account has a “credit balance”. If debits and credits equal each, then we have a “zero balance”. Accounts with a net Debit balance are generally shown as Assets, while accounts with a net Credit balance are generally shown as Liabilities. The equity section and retained earnings account, basically reference your profit or loss. Therefore that account can be positive or negative (depending on if you made money). When you add Assets, Liabilities and Equity together (using positive numbers to represent Debits and negative numbers to represent Credits) the sum should be Zero.

    Debit cards and credit cards[ edit ]

    Debit cards and credit cards are creative terms used by the banking industry to market and identify each card. [16] From the cardholder’s point of view, a credit card account normally contains a credit balance, a debit card account normally contains a debit balance. A debit card is used to make a purchase with one’s own money. A credit card is used to make a purchase by borrowing money. [17]

    From the bank’s point of view, when a debit card is used to pay a merchant, the payment causes a decrease in the amount of money the bank owes to the cardholder. From the bank’s point of view, your debit card account is the bank’s liability. A decrease to the bank’s liability account is a debit. From the bank’s point of view, when a credit card is used to pay a merchant, the payment causes an increase in the amount of money the bank is owed by the cardholder. From the bank’s point of view, your credit card account is the bank’s asset. An increase to the bank’s asset account is a debit. Hence, using a debit card or credit card causes a debit to the cardholder’s account in either situation when viewed from the bank’s perspective.

    General ledgers[ edit ]

    General ledger is the term for the comprehensive collection of T-accounts (it is so called because there was a pre-printed vertical line in the middle of each ledger page and a horizontal line at the top of each ledger page, like a large letter T). Before the advent of computerised accounting, manual accounting procedure used a book (known as a ledger) for each T-account. The collection of all these books was called the general ledger. The chart of accounts is the table of contents of the general ledger. Totaling of all debits and credits in the general ledger at the end of a financial period is known as trial balance.

    “Day Books” or journals are used to list every single transaction that took place during the day, and the list is totalled at the end of the day. These daybooks are not part of the double-entry bookkeeping system . The information recorded in these daybooks is then transferred to the general ledgers. Modern computer software now allows for the instant update of each ledger account – for example, when recording a cash receipt in a cash receipts journal a debit is posted to a cash ledger account with a corresponding credit in the ledger account for which the cash was received. Not every single transaction need be entered into a T-account. Usually only the sum of the book transactions (a batch total) for the day is entered in the general ledger.

    The five accounting elements[ edit ]

    There are five fundamental elements [12] within accounting. These elements are as follows: Assets , Liabilities , Equity (or Capital), Income (or Revenue) and Expenses . The five accounting elements are all affected in either a positive or negative way. A credit transaction does not always dictate a positive value or increase in a transaction and similarly, a debit does not always indicate a negative value or decrease in a transaction. An asset account is often referred to as a “debit account” due to the account’s standard increasing attribute on the debit side. When an asset (e.g. an espresso machine) has been acquired in a business, the transaction will affect the debit side of that asset account illustrated below:

    Asset
    Debits (Dr)Credits (Cr)
    X 

    The “X” in the debit column denotes the increasing effect of a transaction on the asset account balance (total debits less total credits), because a debit to an asset account is an increase. The asset account above has been added to by a debit value X, i.e. the balance has increased by £X or $X. Likewise, in the liability account below, the X in the credit column denotes the increasing effect on the liability account balance (total credits less total debits), because a credit to a liability account is an increase.

    All “mini-ledgers” in this section show standard increasing attributes for the five elements of accounting.

    Liability
    Debits (Dr)Credits (Cr)
     X
    Income
    Debits (Dr)Credits (Cr)
     X
    Expenses
    Debits (Dr)Credits (Cr)
    X 
    Equity
    Debits (Dr)Credits (Cr)
     X

    Summary table of standard increasing and decreasing attributes for the five accounting elements:

    ACCOUNT TYPEDEBITCREDIT
    Asset+
    Liability+
    Income+
    Expense+
    Equity+

    Principle[ edit ]

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    Each transaction that takes place within the business will consist of at least one debit to a specific account and at least one credit to another specific account. A debit to one account can be balanced by more than one credit to other accounts, and vice versa. For all transactions, the total debits must be equal to the total credits and therefore balance.

    The general accounting equation is as follows:

    Assets = Equity + Liabilities, [18]
    A = E + L.

    The equation thus becomes A – L – E = 0 (zero). When the total debts equals the total credits for each account, then the equation balances.

    The extended accounting equation is as follows:

    Assets + Expenses = Equity/Capital + Liabilities + Income,
    A + Ex = E + L + I.

    In this form, increases to the amount of accounts on the left-hand side of the equation are recorded as debits, and decreases as credits. Conversely for accounts on the right-hand side, increases to the amount of accounts are recorded as credits to the account, and decreases as debits.

    This can also be rewritten in the equivalent form:

    Assets = Liabilities + Equity/Capital + (Income − Expenses),
    A = L + E + (I − Ex),

    where the relationship of the Income and Expenses accounts to Equity and profit is a bit clearer. [19]
    Here Income and Expenses are regarded as temporary or nominal accounts which pertain only to the current accounting period whereas Asset, Liability, and Equity accounts are permanent or real accounts pertaining to the lifetime of the business. [20] The temporary accounts are closed to the Equity account at the end of the accounting period to record profit/loss for the period. Both sides of these equations must be equal (balance).

    Each transaction is recorded in a ledger or “T” account, e.g. a ledger account named “Bank” that can be changed with either a debit or credit transaction.

    In accounting it is acceptable to draw-up a ledger account in the following manner for representation purposes:

    Bank
    Debits (Dr)Credits (Cr)
      
      
      
      

    Accounts pertaining to the five accounting elements[ edit ]

    Accounts are created/opened when the need arises for whatever purpose or situation the entity may have. For example, if your business is an airline company they will have to purchase airplanes, therefore even if an account is not listed below, a bookkeeper or accountant can create an account for a specific item, such as an asset account for airplanes. In order to understand how to classify an account into one of the five elements, a good understanding of the definitions of these accounts is required. Below are examples of some of the more common accounts that pertain to the five accounting elements:

    Asset accounts[ edit ]

    Asset accounts are economic resources which benefit the business/entity and will continue to do so. [21] They are Cash, bank, accounts receivable , inventory, land, buildings/plant, machinery, furniture, equipment, supplies, vehicles, trademarks and patents, goodwill, prepaid expenses, prepaid insurance, debtors (people who owe us money, due within one year), VAT input etc.

    Two types of basic asset classification: [22]

    • Current assets: Assets which operate in a financial year or assets that can be used up, or converted within one year or less is called current assets. For example, Cash, bank, accounts receivable , inventory (people who owe us money, due within one year), prepaid expenses, prepaid insurance, VAT input and many more.
    • Non-current assets: Assets that are not recorded in transactions or hold for more than one year or in an accounting period is called Non-current assets. For example, land, buildings/plant, machinery, furniture, equipment, vehicles, trademarks and patents, goodwill etc.

    Liability accounts[ edit ]

    Liability accounts record debts or future obligations a business or entity owes to others. When one institution borrows from another for a period of time, the ledger of the borrowing institution categorises the argument under liability accounts. [23]

    The basic classifications of liability accounts are:

    • Current liability, when money only may be owed for the current accounting period or periodical. Examples include accounts payable , salaries and wages payable, income taxes, bank overdrafts, accrued expenses, sales taxes, advance payments (unearned revenue), debt and accrued interest on debt, customer deposits, VAT output, etc.
    • Long-term liability, when money may be owed for more than one year. Examples include trust accounts, debenture, mortgage loans and more.

    Equity accounts[ edit ]

    Equity accounts record the claims of the owners of the business/entity to the assets of that business/entity. [24]
    Capital, retained earnings , drawings, common stock, accumulated funds, etc.

    Income/revenue accounts[ edit ]

    Income accounts record all increases in Equity other than that contributed by the owner/s of the business/entity. [25]
    Services rendered, sales, interest income, membership fees, rent income, interest from investment, recurring receivables,donation etc.

    Expense accounts[ edit ]

    Expense accounts record all decreases in the owners’ equity which occur from using the assets or increasing liabilities in delivering goods or services to a customer – the costs of doing business. [26]
    Telephone, water, electricity, repairs, salaries, wages, depreciation, bad debts, stationery, entertainment, honorarium , rent, fuel, utility, interest etc.

    Example[ edit ]

    Quick Services business purchases a computer for £500, on credit, from ABC Computers. Recognize the following transaction for Quick Services in a ledger account (T-account):

    Quick Services has acquired a new computer which is classified as an asset within the business. According to the accrual basis of accounting, even though the computer has been purchased on credit, the computer is already the property of Quick Services and must be recognised as such. Therefore, the equipment account of Quick Services increases and is debited:

    Equipment (Asset)
    (Dr)(Cr)
    500 
      
      
      

    As the transaction for the new computer is made on credit, the payable “ABC Computers” has not yet been paid. As a result, a liability is created within the entity’s records. Therefore, to balance the accounting equation the corresponding liability account is credited:

    Payable ABC Computers (Liability)
    (Dr)(Cr)
     500
      
      
      

    The above example can be written in journal form:

    DrCr
    Equipment500
         ABC Computers (Payable)500

    The journal entry “ABC Computers” is indented to indicate that this is the credit transaction. It is accepted accounting practice to indent credit transactions recorded within a journal.

    In the accounting equation form:

    A = E + L,
    500 = 0 + 500 (the accounting equation is therefore balanced).

    Further examples[ edit ]

    1. A business pays rent with cash: You increase rent (expense) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.
    2. A business receives cash for a sale: You increase cash (asset) by recording a debit transaction, and increase sales (income) by recording a credit transaction.
    3. A business buys equipment with cash: You increase equipment (asset) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.
    4. A business borrows with a cash loan : You increase cash (asset) by recording a debit transaction, and increase loan (liability) by recording a credit transaction.
    5. A business pays salaries with cash: You increase salary (expenses) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.
    6. The totals show the net effect on the accounting equation and the double-entry principle, where the transactions are balanced.
    AccountDebit (Dr)Credit (Cr)
    1.Rent100
    Bank100
    2.Bank50
    Sales50
    3.Equipment5200
    Bank5200
    4.Bank11000
    Loan11000
    5.Salary5000
    Bank5000
    6.Total (Dr)$21350
    Total (Cr)$21350

    T-accounts[ edit ]

    The process of using debits and credits creates a ledger format that resembles the letter “T”. [27] The term “T-account” is accounting jargon for a “ledger account” and is often used when discussing bookkeeping. [28] The reason that a ledger account is often referred to as a T-account is due to the way the account is physically drawn on paper (representing a “T”). The left side (column) of the “T” for Debit (Dr) transactions and the right side (column) of the “T” for Credit (Cr) transactions.

    Debits (Dr)Credits (Cr)
      
      

    Contra account[ edit ]

    All accounts can be debited or credited depending on what transaction has taken place e.g., when a vehicle is purchased using cash, the asset account “Vehicles” is debited as the vehicle account increases, and simultaneously the asset account “Bank or Cash” is credited due to the payment for the vehicle using cash. Some balance sheet items have corresponding contra accounts, with negative balances, that offset them. Examples are accumulated depreciation against equipment, and allowance for bad debts (also known as allowance for doubtful accounts) against accounts receivable. [29] United States GAAP utilizes the term contra for specific accounts only and doesn’t recognize the second half of a transaction as a contra, thus the term is restricted to accounts that are related. For example, sales returns and allowance and sales discounts are contra revenues with respect to sales, as the balance of each contra (a debit) is the opposite of sales (a credit). To understand the actual value of sales, one must net the contras against sales, which gives rise to the term net sales (meaning net of the contras). [30]

    A more specific definition in common use is an account with a balance that is the opposite of the normal balance (Dr/Cr) for that section of the general ledger . [30] An example is an office coffee fund: Expense “Coffee” (Dr) may be immediately followed by “Coffee – employee contributions” (Cr). [31] Such an account is used for clarity rather than being a necessary part of GAAP ( generally accepted accounting principles ). [30]

    Real, personal, and nominal accounts[ edit ]

    Real accounts are assets. Personal accounts are liabilities and owners’ equity and represent people and entities that have invested in the business. Nominal accounts are revenue, expenses, gains, and losses. Accountants close nominal accounts at the end of each accounting period. [32] This method is used in the United Kingdom, where it is simply known as the Traditional approach . [13]

    Transactions are recorded by a debit to one account and a credit to another account using these three “golden rules of accounting”:

    1. Real account: Debit what comes in and credit what goes out
    2. Personal account: Debit who receives and Credit who gives.
    3. Nominal account: Debit all expenses & losses and Credit all incomes & gains
    DebitCredit
    Real (assets)IncreaseDecrease
    Personal (liability)DecreaseIncrease
    Personal (owner’s equity)DecreaseIncrease
    Nominal (revenue)DecreaseIncrease
    Nominal (expenses)IncreaseDecrease
    Nominal (gain)DecreaseIncrease
    Nominal (loss)IncreaseDecrease

    References[ edit ]

    1. ^ “Debit Credit Rules” . Accounting Explained. AccountingExplained.com. Retrieved 4 August 2011.

    2. ^ “Making sense of Debits and Credits in Accounting” . Archived from the original on 10 July 2013. Retrieved 5 May 2013.
    3. ^ “Peachtree For Dummies, 2nd Ed” (PDF). Retrieved 2011-02-06.
    4. ^ Jane Gleeson-White (2012). Double Entry: How the Merchants of Venice Created Modern Finance . W. W. Norton. ISBN   978-0-393-08968-4 .
    5. ^ Nigam, B. M. Lall (1986). Bahi-Khata: The Pre-Pacioli Indian Double-entry System of Bookkeeping. Abacus, September 1986. Retrieved from http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6281.1986.tb00132.x/abstract .
    6. ^ “Basic Accounting Concepts 2 – Debits and Credits” . Retrieved 2011-02-06.
    7. ^ “Wheres’s the “R” in Debit?” by W. Richard Sherman published in The Accounting Historians Journal, Vol. 13, No. 2 (Fall 1986), pp. 137-143.
    8. ^ Analysis or Resolution of Merchant Accompts 3e at WorldCat
    9. ^ “For each one of all the entries that you have made in the Journal you will have to make two in the Ledger. That is, one in the debit (in dare) and one in the credit (in havere). In the Journal the debtor is indicated by per, the creditor by a, as we have said…The debitor entry must be at the left, the creditor one at the right.” Geijsbeek, John B (1914). Ancient Double-entry Bookkeeping . Retrieved 2016-07-31. A facsimile of the original Italian is given on the facing page to the translation.
    10. ^ Geijsbeek, John B (1914). Ancient Double-entry Bookkeeping . p. 15. Retrieved 2016-07-31.
    11. ^ Jackson, J.G.C., “The History of Methods of Exposition of Double-Entry Bookkeeping in England.” Studies in the History of Accounting, A. C. Littleton and Basil S. Yamey (eds.). Homewood, III.: Richard D. Irwin, 1956. p. 295
    12. ^ a b Pieters, A. Dempsey, H. N. (2009). Introduction to financial accounting (7th ed.). Durban: Lexisnexis. ISBN   978-0-409-10580-3 .
    13. ^ a b Accountancy: Higher Secondary First Year (PDF) (First ed.). Tamil Nadu Textbooks Corporation. 2004. pp. 28–34. Retrieved 12 July 2011.
    14. ^ IFRS for SMEs. 1st Floor, 30 Cannon Street, London EC4M 6XH, United Kingdom: IASB (International Accounting Standards Board). 2009. p. 14. ISBN   978-0-409-04813-1 .
    15. ^ David L. Kolitz; A. B. Quinn; Gavin McAllister (2009). Concepts-Based Introduction to Financial Accounting . Juta and Company Ltd. pp. 86–89. ISBN   978-0-7021-7749-1 .
    16. ^ Difference between Credit Card and Debit Card . Diffbetween.org (2012-02-08). Retrieved on 2012-05-04.
    17. ^ “Accounting made easy 4 – Debits and Credits” . Retrieved 13 March 2011.
    18. ^ Financial Accounting 5th Ed., p. 47, Horngren, Harrison, Bamber, Best, Fraser, Willet, Pearson/PrenticeHall, 2006.
    19. ^ Financial Accounting 5th Ed., p. 14–15, Horngren, Harrison, Bamber, Best, Fraser, Willet, Pearson/PrenticeHall, 2006.
    20. ^ Financial Accounting 5th Ed., p. 145, Horngren, Harrison, Bamber, Best, Fraser, Willet, Pearson/PrenticeHall, 2006.
    21. ^ Financial Accounting, Horngren, Harrison, Bamber, Best, Fraser Willet, pp. 13, 44, Pearson/PrenticeHall 2006.
    22. ^ Maire Loughran (24 April 2012). Intermediate Accounting For Dummies . John Wiley & Sons. p. 86. ISBN   978-1-118-17682-5 .
    23. ^ Financial Accounting, Horngren, Harrison, Bamber, Best, Fraser Willet, pp. 14, 45, Pearson/PrenticeHall 2006.
    24. ^ Financial Accounting, Horngren, Harrison, Bamber, Best, Fraser Willet, pp. 14, 46, Pearson/PrenticeHall 2006.
    25. ^ Financial Accounting, Horngren, Harrison, Bamber, Best, Fraser Willet, p. 14, Pearson/PrenticeHAll 2006.
    26. ^ Financial Accounting, Horngren, Harrison, Bamber, Best, Fraser Willet, p. 15, Pearson/PrenticeHall 2006.
    27. ^ Weygandt, Jerry J. (2009). Financial Accounting. John Wiley and Sons. p. 53. ISBN   978-0-470-47715-1 .
    28. ^ Cusimano, David. “Accounting Abbreviations – Helping You Understand Accounting Jargon” . Loughborough. Retrieved 18 August 2011.
    29. ^ “Normal balances in the accounting double entry system” . The Accounting Adventurista. Retrieved March 3, 2014.
    30. ^ a b c “Contra account definition” . Accounting Coach. Retrieved March 3, 2014.
    31. ^ “Q&A: What is a contra expense account?” . Accounting Coach. Retrieved March 3, 2014.
    32. ^ “Account Types or Kinds of Accounts :: Personal, Real, Nominal” . Retrieved 2011-04-08.

    External links[ edit ]

    Look up debit  or credit in Wiktionary, the free dictionary.

    Retrieved from ” https://en.wikipedia.org/w/index.php?title=Debits_and_credits&oldid=860121942 ”
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        Free Guide to
        Bookkeeping Concepts

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        Bookkeeping (Explanation)

        Print PDF

        1. Part 1

          Introduction; Bookkeeping: Past and Present
        2. Part 2

          Accrual Method
        3. Part 3

          Double-Entry, Debits and Credits
        4. Part 4

          General Ledger Accounts

        5. Part 5

          Debits and Credits in the Accounts
        6. Part 6

          Asset Accounts
        7. Part 7

          Liability and Stockholders’ Equity Accounts
        8. Part 8

          Income Statement Accounts
        9. Part 9

          Recording Transactions; Bank Reconciliation
        10. Part 10

          Adjusting Entries; Reversing Entries
        11. Part 11

          Balance Sheet; Income Statement; Balance Sheet and Income Statement are Linked
        12. Part 12

          Cash Flow Statement
        13. Part 13

          Statement of Stockholders’ Equity; Closing Cut-Off; Importance of Controls


        Debits and Credits in the Accounts

        If you already understand debits and credits, the following table summarizes how debits and credits are used in the accounts.

        61X-table-05

        If you are not familiar with debits and credits or if you want a better understanding, we will provide a few insights to help you. We will also provide links to our visual tutorial, quiz, puzzles, etc. that will further assist you.

        Accounting Equation Can Help

        The accounting equation is a central part of bookkeeping and accounting. It can also provide insights into debits and credits. The basic accounting equation is:

        Assets = Liabilities + Stockholders’ equity (if a corporation)

        or

        Assets = Liabilities + Owner’s equity (if a sole proprietorship)

        With double-entry accounting, the accounting equation should always be in balance. In other words, not only will debits be equal to credits, but the amount of assets will be equal to the amount of liabilities plus the amount of owner’s equity.

        The accounting equation is also the framework of the balance sheet, one of the main financial statements. Hence the balance sheet must also be in balance.

        We will use the accounting equation to explain why we sometimes debit an account and at other times we credit an account.

        Assets are on the left side of the accounting equation.
        Asset account balances should be on the left side of the accounts.

        In the accounting equation you can see that assets are on the left side of the equation:

        61X-table-text-02

        Earlier you learned that debit means left side. Recall our T-account that showed debits on the left side:

        61X-t-account-05

        Hence, asset accounts such as Cash, Accounts Receivable, Inventory, and Equipment should have debit balances.

        Liabilities are on the right side of the accounting equation.
        Liability account balances should be on the right side of the accounts.

        In the accounting equation you can see that liabilities are on the right side of the equation:

        61X-table-text-03

        Earlier you learned that credit means right side. Recall our T-account that showed credits on the right side:

        61X-t-account-06

        Thus liability accounts such as Accounts Payable, Notes Payable, Wages Payable, and Interest Payable should have credit balances.

        Stockholders’ equity is on the right side of the accounting equation.
        Stockholders’ equity account balances should be on the right side of the accounts.

        In the accounting equation you can see that stockholders’ equity is on the right side of the equation:

        61X-table-text-04

        Again, credit means right side and our T-account showed credits on the right side. This means that stockholders’ equity accounts such as Common Stock, Retained Earnings, and M J Smith, Capital should have credit balances.

        Example

        To demonstrate the debits and credits of double-entry with a transaction, let’s assume that a new corporation is formed and the stockholders invest $100,000 in exchange for shares of common stock. There are two effects of this transaction:

        1. The corporation receives cash, which is recorded as a corporation asset.
        2. The corporation issues shares of common stock. The amount received for the shares will be recorded as part of the corporation’s stockholders’ equity.

        Here’s how the transaction will impact the accounting equation and the company’s balance sheet:

        61X-table-text-05

        Here is what will occur in the general ledger accounts:

        61X-t-account-07
        61X-t-account-08

        If this transaction is entered in a general journal, it would appear as follows:

        61X-journal-02

        Revenues increase stockholders’ equity (which is on the right side of the accounting equation).
        Therefore the balances in the revenue accounts will be on the right side.

        To illustrate, let’s assume that a company provides a service and bills the customer $400 with the amount due in 30 days. Two things occur:

        1. Revenues of $400 are earned and that causes stockholders’ equity to increase.
        2. The company earns the right to receive $400. This increases the company’s asset account Accounts Receivable.

        Here’s the effect on the accounting equation and the company’s balance sheet as a result of earning the revenues:

        61X-table-text-06

        Here is what occurs in the general ledger accounts:

        61X-t-account-09
        61X-t-account-10

        Note: Even though stockholders’ equity will increase, the transaction is recorded in the account Service Revenues. The reason is that we want the amount of revenues to be reported on the current period’s income statement. (In other words, we temporarily credit Service Revenues instead of crediting the stockholders’ equity account Retained Earnings. At the end of the accounting year, the balances in all of the income statement accounts will be closed/transferred to Retained Earnings.)

        If this transaction were entered in a general journal, it would appear as follows:

        61X-journal-03

        Expenses decrease stockholders’ equity (which is on the right side of the accounting equation).
        Therefore expense accounts will have their balances on the left side.

        To reduce the normal credit balance in stockholders’ equity accounts, a debit will be needed. Hence, the accounts such as Rent Expense, Advertising Expense, etc. will have their balances on the left side.

        For example, when a company pays cash of $150 for advertising materials that are distributed immediately at a local event, two things occur:

        1. An expense of $150 occurred and the expense will cause stockholders’ equity to decrease.
        2. The company has reduced its asset Cash by $150.

        The effect on the accounting equation and the company’s balance sheet is:

        61X-table-text-07

        The effect on the company’s general ledger accounts is shown here:

        61X-t-account-11
        61X-t-account-12

        Note: Even though this expense causes stockholders’ equity to decrease, the transaction is recorded in the account Advertising Expense. The reason is that we want the current period’s income statement to report this expense. (In other words, we temporarily debit Advertising Expense instead of debiting the stockholders’ equity account Retained Earnings. At the end of the accounting year, all of the balances in the income statement accounts will be closed/transferred to Retained Earnings.)

        If this transaction were entered in a general journal, it would appear as follows:

        61X-journal-04

        A few tips about debits and credits:

        • When cash is received, debit Cash.
        • When cash is paid out, credit Cash.
        • When revenues are earned, credit a revenue account.
        • When expenses are incurred, debit an expense account.

        Here are some common transactions with the appropriate debits and credits:

        61X-table-06

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