Debits and Credits - FundsNet (2024)

Debits and credits always confuse a lot of people.

With some debits increasing other types of accounts, some will result in a decrease.

The question that people always ask is, when should a debit be used and when should credit be used?

Debits and Credits in Action

Companies today use Double Entry Bookkeeping when recording transactions of a company during the accounting period.

Under this system, when bookkeepers enter a journal entry, there should be debit and credit amounts entered and they should be equal.

A company’s chart of accounts will represent the Balance Sheet and Income Statement accounts.

For these accounts to increase or decrease, they must be debited or credited.

In accounting, each account has a normal balance.

Assets have a normal debit balance, while liabilities and owner’s equity have normal credit balances.

Income has a normal credit balance and expenses have a normal debit balance.

For example, ABC Corporation made a total cash sales of $100,000 for the month of January.

To record this transaction under the Double Entry Bookkeeping System, the journal entry will be as follows:

Since Cash (an Asset) has a normal debit balance and Sales (an Income account) has a normal credit balance, the transaction above increased the Cash and Sales accounts.

To decrease these accounts, Cash must be credited and Sales must be debited.

Suppose ABC Corporation purchases a piece of furniture for $20,000 in cash, the journal entry to record this will be:

To show the cash account transactions in a table, it will be:

The Cash account will have a debit balance of $80,000.

How Debits and Credits Affect Liability Accounts

Liabilities represent the obligations that a company owes.

As mentioned above, liabilities represent a normal credit balance.

Each time a liability account increases, it must be credited.

To decrease it, it must be debited.

For example, ABC Corporation is looking at expanding their current operations and took a bank loan from Z Bank for $500,000.

To record the receipt of the loan, the bookkeeper of ABC Corporation will pass the following journal entry:

The bank loan increases the cash account of a company by $500,000 but at the same time, the liability also increases by the same amount.

When the company makes its annual installment of $50,000 for the next 10 years, the journal entry will then be:

For each annual payment that a company makes towards the bank loan, both the cash and bank loan accounts decrease.

How Debits and Credits Affect Equity Accounts

Just like the liability account, equity accounts have a normal credit balance. To increase it, a credit entry has to be passed.

For example, X Company received additional capital from one of its partners – Partner B – for $150,000 to expand its operations. The receipt of cash from Partner B will be recorded as

The amount received by X Company from Partner B increased the Cash account by $150,000 and also increased the Equity amount of Partner B by $150,000.

Debits and Credits Chart

Debits and Credits can be a little complicated to understand in the beginning. To understand it better, one can take note of its effect on specific types of accounts:

It should also be noted that debits are always recorded on the left and credits are always recorded on the right.