Accounting is the practice of recording a company’s financial transactions. To do this, it relies on two fundamental records: credit and debit in accounting. The ladder, a debit, is a journal entry with the ability to increase an asset or expense, while decreasing capital, liability or revenue. When using double-entry bookkeeping, these entries are recorded on the left-hand side.
Debits mark one half of every financial transaction, offset by a credit to a different account on the opposite side. These debit-credit pairs show money entering and leaving accounts, charting its course through the organization.
Debits are best-understood as a financial accounting tool when used in context. Here’s a look at the role of debits within double-entry accounting and its relationship to different accounts.
Debits vs. Credits in Double-Entry Accounting
Credits and debits function opposite one another in double-entry accounting. Every debit requires an equal, offsetting credit to a different account. As per double-entry accounting standards, accountants always record transactions in pairs: credit to one, debit to the other.
For example, if ABC Company takes out a loan for $250,000, it would record the transaction as follows:
- Debit the cash account for $250,000
- Credit the loans payable account for $250,000
Though a basic example, this transaction shows the relevance of double-entry accounting and the purpose of credits and debits. Any accountant can match up these two transactions, which serves to not only validate them, but also to bring transparency and traceability to cash flows.
How Debits Affect Different Accounts
The role of debits when accounting for different types of financial transactions all comes down to economic benefit: the flow of capital from a source to a destination. Here’s a look at how it affects different accounts when applied as part of an economically beneficial transaction:
- Dividends. When a company issues a dividend, it reduces equity and increases liabilities. Debits represent an increase to this account.
- Expenses. Debiting an expense account involves an increase to the balance, usually offset by a decrease in liability, revenue or equity.
- Assets. A debit to asset accounts will increase the balance. For example, adding inventory will see a reduction in cash and an increase in units.
- Liabilities. Debits decrease the balance of liabilities accounts. The best example is a bank loan. Debiting represents payback of the loan, thus a reduction in liability.
- Equity. Debits to an equity account will decrease them, since they represent increased ownership stake—thus, a larger claim against the company.
- Revenue. A debit to revenue is equivalent to a decrease, since it records money going out of the business, used for expenses.
Again, economic benefit is the prime driver of debits and its offsetting credits. Debits are always the destination of economic benefit: capital flowing into an account. Accountants need to always keep this in mind when recording transactions, because the offsetting credit needs to represent the source of economic benefit. This is why accuracy is fundamental to double-entry accounting.
Common Accounting Actions
There are many common accounting actions that businesses will record daily. Here’s a look at how they’re debited (and credited) based on the nature of the transaction and the accounts affected by the double-entry standard:
- Sale for cash: Debit cash, credit revenue
- Sale on credit: Debit accounts receivable, credit revenue
- Accounts receivable: Debit cash, credit accounts receivable
- Accounts payable: Debit accounts payable, credit cash
- Pay employees: Debit wages and payroll, credit cash
Credits always affect the account the capital comes from; debits always affect the account it moves to. There are always two accounts; however, many transactions can and do involve more.
What Happens When Debits Outweigh Credits?
The purpose of double-entry accounting is to ensure balance between all credits and debits. At any point in a financial accounting period, debits should equal credits. If they don’t there’s a problem. When they outweigh credits, it tends to mean one of several things has occurred.
- Double-debiting or misattributing a credit as a debit can lead to an imbalance between the accounts. Thankfully, accounting software has safeguards built in to prevent this type of misattribution.
- Clerical error can create imbalance. A missed or moved decimal point, or mistyped number can mix up the debit. For example, entering $1,005 as $1,050 or $100,050 will cause excessive debiting. Again, accounting software protects against this.
- Misattributing can also throw off the balance sheet. For example, debiting assets instead of equity can create conflicting figures between these accounts, leading to an excess in debits.
When the balance sheet weighs in favor of debits, accounts need to perform an audit. This situation, called a debit balance, needs resolution before the company closes its books. This is the purpose of a trial balance: to ensure everything matches up before the end of the accounting period.
Fundamental Part of Accounting
Debits aren’t good or bad in the context of accounting; rather, they represent the chain of recordkeeping that enables transparency in accounting. Together with credits, they’re a key part of illuminating a company’s cash flows and financial health. Each one made to a company’s account needs an equal, offsetting series of credits elsewhere in the books, creating a trail for accountants and auditors to follow.
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Keep in mind that debits always increase assets and expenses, while decreasing liabilities, revenue and equity. Recognize this within the context of a company’s balance sheet and income statement to better-comprehend the financial health and operations of that organization.