7 Tips For Understanding Credits and Debits

An easy way to understand credits and debits. Image: Unsplash

Credits and debits are essential parts of the accounting system, which businesses use to record transactions, keep track of liabilities and assets. Once you understand their differences, you’ll be able to categorize and enter transactions properly.

These concepts are traditionally difficult to understand because they aren’t very intuitive. Nevertheless, the most important rule to bear in mind is that debits are constantly on the left side while credits are on the right. If you’re having a difficult time understanding these vital concepts, these tips will help shed some light.

1. Debits versus Credits

A debit is an entry posted when there’s an addition of expenses, assets, and reduction or losses in the incomes and liabilities. If the debit side surpasses the credit side, it’s considered a debit balance.

Credit, on the other hand, is an entry posted when there’s an addition to incomes, liabilities, and owner’s equity or decrease in assets, losses, and expenses. If the credit side surpasses the debit side, it’s considered a credit balance.

2. The rules for credits and debits on the balance sheet

When executing a transaction on a company’s balance sheet, an accountant uses credits and debits to record the increasing and decreasing accounts.

For instance, if a business takes out a loan, the transaction would appear as a credit and debit; this would increase its assets (the cash provided by the loan) and liabilities (the loan).

On the asset side, a debit increases an account’s balance while a credit reduces that account’s balance of the balance sheet. On the other hand, the rule is reversed when it comes to the liabilities side.

3. Credit and Debit Usage

During the creation of an accounting transaction, at least two accounts are constantly impacted-with a debit appearing against one account while a credit appears against another.

Bear in mind that there’s no upper limit to the accounts involved in a transaction. However, the minimum number of accounts that should be in use is two. Remember, the totals of the credits and debits for every transaction should always equal for an accounting transaction to be in balance.

4. Recording credits and debits for Asset accounts

Assets are items owned by a business or company, such as accounts receivable, inventory, and any other account under fixed or current assets on the balance sheet. Bear in mind that debits appear on the left side while credits are on the right. While debits are increases in asset accounts, credits are decreases of the same.

5. Accounting Inventory credits and debits

Inventory Increases

Inventory increases are frequently the result of purchases. The journal entry to inventory increase is a credit to cash and debit to inventory.

Decreases in Inventory

An inventory reduces with sales and the entry concerning inventory is to increase the cost of sold goods/debit and to credit/reduce inventory.

6. Credits and debits on the income statement

The goal of the income statement is to calculate the loss or net profit for the company. A company reports its debits from other accounts as expenditures on the income statement. Other accounts may comprise employee wages, rent, and utilities.

On the other hand, credits from other accounts appear as revenue on the income statement. Revenues comprise professional fees, rental income, and inventory sales.

7. Use t-account for illustrating debit and credit effect

A T account is a graphic depiction of a general ledger account. The account’s name appears above the “T” (at times together with the account number) while the grand total for every “T” account appears beneath the account. A number of these accounts are usually grouped together to reveal the accounts affected by a transaction.

Final Thoughts

While credits and debits can be somewhat confusing, it’s possible to understand the differences between the two accounting concepts. If you’re still unclear about the two, these tips will guide you.

Dailey Bookkeeping Services is a Xero Certified SILVER Partner and a QuickBooks Online Certified Advisor, so if we can help you with your credits and debits needs, just give us a call, we would love to help you!  The owner, Jacqueline Dailey is a Certified Public Bookkeeper, an Advanced Certified QuickBooks and QuickBooks Online ProAdvisor, a Sleeter Group Certified QuickBooks Consultant and a Xero Certified Silver Partner. We work remotely so we can work with any company located in the U.S. If we can help you with this process or provide you with custom reporting, please give us a call. If we cannot help you, we will refer you to someone who can!  Feel free to visit our website at http://www.daileybookkeeping.com.

Dailey Bookkeeping Services
Dailey Bookkeeping Services

 

Leave a Reply

Your email address will not be published. Required fields are marked *