Debits and credits: Definition, examples, and accounting basics

Credits and debits play a crucial role in the double-entry bookkeeping system and are the foundation on which financial transactions are recorded and balanced. Read on to better understand these core accounting concepts, including what they are, how they work, their benefits, examples, history, and more. 

What are debits and credits?

Debits and credits are fundamental concepts in accounting that form the basis of the double-entry bookkeeping system.¹ This system is used to record financial transactions accurately and maintain the integrity of a company's financial records. In this context, "debits" and "credits" do not refer to increases or decreases in value, but indicate how transactions are recorded in different accounts. A debit entry represents an increase in assets or expenses and a decrease in liabilities, equity, or revenue. Conversely, a credit entry signifies an increase in liabilities, equity, or revenue, and a decrease in assets or expenses.

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Why are debits and credits important?

Debits and credits serve as the foundation of accurate financial record-keeping and reporting. By properly applying debits and credits, accountants ensure that the accounting equation (assets = liabilities + equity) remains balanced. This principle provides a clear and systematic approach to tracking financial activities, enabling accountants to generate reliable financial statements.

How do debits and credits work?

Debits and credits work in tandem within the double-entry bookkeeping system to ensure that each financial transaction is accurately recorded and balanced. A debit entry increases asset or expense accounts and decreases liability, revenue, and equity accounts. On the other hand, credit entries are employed to decrease asset or expense accounts and increase liability, revenue, and equity accounts. For every transaction entered into the system, there must be at least one debit entry and one credit entry, and the total debits must equal the total credits.

Benefits of debits and credits

Debit and credit entries provide several benefits in the field of accounting. Let's explore some of these benefits in more detail:

• Accurate financial reporting: Debits and credits ensure that each financial transaction is recorded accurately and consistently.
• Error detection: Since every transaction requires corresponding debits and credits that must balance, any discrepancies between the two sides of the equation can signal a mistake in the recording process. This built-in error-checking mechanism prompts accountants to review and rectify errors before they can significantly impact the integrity of financial records.
• Consistent methodology: This uniform approach allows accountants and financial professionals to communicate and understand financial data effectively across different industries and organizations.

Examples of debits and credits

To illustrate the application of debits and credits, here are some common examples:

Cash purchase of supplies

When a business buys supplies using cash, it results in a decrease in the cash account (credited) and an increase in the supplies account (debited).

Loan received from bank

In the case of receiving a loan from a bank, the business cash account is increased (debited) as the loan amount enters the company. Simultaneously, a liability account, often labeled as "Loan Payable" or a similar term, is credited. This reflects the company's obligation to repay the loan in the future.

Sales of goods on credit

When a business sells goods to a customer on credit, the revenue account (sales) is credited, recognizing the increase in revenue generated by the sale. At the same time, the accounts receivable account is debited, representing the amount owed by the customer.

Payment of salaries 

In this scenario, the salaries expense account is debited, reducing the company's net income. At the same time, the company's cash account is credited, reflecting the decrease in cash due to the outgoing payment.

How to record transactions with debits and credits

Recording transactions with debits and credits follows a consistent process. Here's a step-by-step guide: 

1. Identify the accounts: Determine the accounts impacted by the transaction. It usually involves at least two accounts. 
2. Determine debit or credit: Apply the appropriate debit or credit rule to each account based on the transaction's nature.  
3. Amounts: Assign the monetary value to each debit and credit entry. 
4. Entry sequence: Record the debit entry first, followed by the credit entry. This maintains the equation's balance. 
5. Verify the equation: Ensure that the equation (assets = liabilities + equity) remains balanced after recording the transaction.

Debits and credits in different account categories

Debits and credits are applied differently based on the account categories involved. Here's a breakdown:

Assets

• Increase: Debited (e.g., cash, inventory)
• Decrease: Credited (e.g., accounts payable, sales)

Liabilities

• Increase: Credited (e.g., loans, accounts payable)
• Decrease: Debited (e.g., loan payments, reduction in payables)

Equity

• Increase: Credited (e.g., owner's investment, retained earnings)
• Decrease: Debited (e.g., owner's withdrawals, net loss)

Revenue

• Increase: Credited (e.g., sales, service income)
• Decrease: Debited (e.g., sales returns, discounts)

Expenses

• Increase: Debited (e.g., salaries, utilities)
• Decrease: Credited (e.g., expense reversals, discounts received)

Frequently asked questions 

Is it possible to have a transaction with more than one debit or credit?

Yes, complex transactions often involve multiple accounts and may require more than one debit and credit entry to maintain the equation's balance.

Are debits and credits relevant in cash-based accounting?

Cash-based accounting primarily focuses on cash inflows and outflows, and the concept of debits and credits is not as prominent as in accrual-based accounting. However, understanding debits and credits is still beneficial for accurate financial reporting.

How do debits and credits affect the calculation of net income?

Debits and credits impact the calculation of net income by reflecting changes in revenue, expenses, gains, and losses in a company's financial records. Debits are used to record increases in expenses and decreases in revenue, while credits signify increases in revenue and decreases in expenses. The net difference between total debits and total credits ultimately determines the company's net income, with a positive difference indicating profit and a negative difference indicating a loss.  

Sources: 

1. Paff, L. (2021, February 5). 1.4 rules of debit (DR) and Credit (CR). Financial and Managerial Accounting. https://psu.pb.unizin.org/acctg211/chapter/rules-of-debit-dr-and-credit-cr/
2.  Hayes, A. (2023, June 13). Double entry: What it means in accounting and how it’s used. Investopedia. https://www.investopedia.com/terms/d/double-entry.asp 
3. Luca Pacioli’s double-entry system of accounting: A critique. - core. (n.d.-b). https://core.ac.uk/download/pdf/234631058.pdf