Debits And Credits - Fikre Accountancy
Debits and CreditsIntroduction to Debits and CreditsWhat are debits and credits?Debits and credits are terms used by bookkeepers and accountants when recording transactions inthe accounting records. The amount in every transaction must be entered in one account as a debit(left side of the account) and in another account as a credit (right side of the account). This doubleentry system provides accuracy in the accounting records and financial statements.The initial challenge is understanding which account will have the debit entry and which account willhave the credit entry. Before we explain and illustrate the debits and credits in accounting andbookkeeping, we will discuss the accounts in which the debits and credits will be entered or posted.What Is An Account?To keep a company's financial data organized, accountants developed a system that sortstransactions into records called accounts. When a company's accounting system is set up, theaccounts most likely to be affected by the company's transactions are identified and listed out. Thislist is referred to as the company's chart of accounts. Depending on the size of a company and thecomplexity of its business operations, the chart of accounts may list as few as thirty accounts or asmany as thousands. A company has the flexibility of tailoring its chart of accounts to best meet itsneeds.Within the chart of accounts the balance sheet accounts are listed first, followed by the incomestatement accounts. In other words, the accounts are organized in the chart of accounts as follows: AssetsLiabilitiesOwner's (Stockholders') EquityRevenues or IncomeExpensesGainsLossesClick here to see a sample chart of accounts.
Double-Entry AccountingBecause every business transaction affects at least two accounts, our accounting system is known asa double-entry system. (You can refer to the company's chart of accounts to select the properaccounts. Accounts may be added to the chart of accounts when an appropriate account cannot befound.)For example, when a company borrows ETB 600,000 from a bank, the transaction will affect thecompany's Cash account and the company's Notes Payable account. When the company repays thebank loan, the Cash account and the Notes Payable account are also involved.If a company buys supplies for cash, its Supplies account and its Cash account will be affected. If thecompany buys supplies on credit, the accounts involved are Supplies and Accounts Payable.If a company pays the rent for the current month, Rent Expense and Cash are the two accountsinvolved.If a company provides a service and gives the client 30 days in which to pay, the company's ServiceRevenues account and Accounts Receivable are affected.Although the system is referred to as double-entry, a transaction may involve more than twoaccounts. An example of a transaction that involves three accounts is a company's loan payment toits bank of ETB 3,000. This transaction will involve the following accounts: Cash, Notes Payable, andInterest Expense.(If you use accounting software you may not actually see that two or more accounts are beingaffected due to the user-friendly nature of the software. For example, let's say that you write acompany check by means of your accounting software. Your software automatically reduces yourCash account and prompts you only for the other accounts affected.)Special Feature: Review what you are learning by working the three interactive crosswordpuzzles dedicated to this topic. They are completely free.Click here for the Debits and Credits Crossword PuzzlesDebits and CreditsAfter you have identified the two or more accounts involved in a business transaction, you must debitat least one account and credit at least one account.To debit an account means to enter an amount on the left side of the account. To credit an accountmeans to enter an amount on the right side of an account.
Here's a TipDebit means- leftCredit means- rightGenerally these types of accounts are increased with a debit: Dividends (Draws) Expenses Assets LossesYou might think of D - E - A - L when recalling the accounts that are increased with a debit.Generally the following types of accounts are increased with a credit: Gains Income Revenues Liabilities Stockholders' (Owner's) Equity You might think of G - I - R - L - S when recalling the accounts that are increased with a credit.To decrease an account you do the opposite of what was done to increase the account. For example,an asset account is increased with a debit. Therefore it is decreased with a credit.The abbreviation for debit is dr. and the abbreviation for credit is cr.T-accountsAccountants and bookkeepers often use T-accounts as a visual aid to see the effect of a transactionor journal entry on the two (or more) accounts involved.
Let's demonstrate the use of these T-accounts with two transactions:1. On June 1, 2020 a company borrows ETB 5,000 from its bank. As a result, the company'sasset Cash must be increased by ETB 5,000 and its liability Notes Payable must beincreased by ETB 5,000. To increase the asset Cash the account needs to be debited. Toincrease the company's liability Notes Payable this account needs to be credited. Afterentering the debits and credits the T-accounts look like this:2. On June 2, 2020 the company repays ETB 2,000 of the bank loan. As a result, thecompany's asset Cash must be decreased by ETB 2,000 and its liability Notes Payable mustbe decreased by ETB 2,000. To reduce the asset Cash the account will need to be credited
for ETB 2,000. To decrease the liability Notes Payable that account will need to be debitedfor ETB 2,000. The T-accounts now look like this:Journal EntriesAnother way to visualize business transactions is to write a general journal entry. Each general journalentry lists the date, the account title(s) to be debited and the corresponding amount(s) followed bythe account title(s) to be credited and the corresponding amount(s). The accounts to be credited areindented. Let's illustrate the general journal entries for the two transactions that were shown in the Taccounts above.
When Cash Is Debited and CreditedBecause cash is involved in many transactions, it is helpful to memorize the following: Whenever cash is received, debit Cash.Whenever cash is paid out, credit Cash.With the knowledge of what happens to the Cash account, the journal entry to record the debits andcredits is easier. Let's assume that a company receives ETB 500 on June 3, 2020 from a customerwho was given 30 days in which to pay. (In May the company had recorded the sale and anaccounts receivable.) On June 3 the company will debit Cash, because cash was received. Theamount of the debit and the credit is ETB 500. Entering this information in the general journal format,we have:All that remains to be entered is the name of the account to be credited. Since this was the collectionof an account receivable, the credit should be Accounts Receivable. (Because the sale was alreadyrecorded in May, you cannot enter Sales again on June 3.)On June 4 the company paid ETB 300 to a supplier for merchandise the company received in May.(In May the company recorded the purchase and the accounts payable.) On June 4 the company willcredit Cash, because cash was paid. The amount of the debit and credit is ETB 300. Entering themin the general journal format, we have:All that remains to be entered is the name of the account to be debited. Since this was the paymenton an account payable, the debit should be Accounts Payable. (Because the purchase was alreadyrecorded in May, you cannot enter Purchases or Inventory again on June 4.)To help you become comfortable with the debits and credits in accounting, memorize the followingtip:Here's a TipWhenever cash is received, the Cashaccount is debited (and another account iscredited).
Whenever cash is paid out, the Cashaccount is credited (and another accountis debited).Normal BalancesWhen looking at an account in the general ledger, the following is the debit or credit balance youwould normally find in the account:Account iabilityOwner’s EquityStockholder’s ossesNormal itDebitCreditDebitRevenues and Gains Are Usually CreditedRevenues and gains are recorded in accounts such as Sales, Service Revenues, Interest Revenues (orInterest Income), and Gain on Sale of Assets. These accounts normally have credit balances that areincreased with a credit entry. In a T-account, their balances will be on the right side.The exceptions to this rule are the accounts Sales Returns, Sales Allowances, and Sales Discounts—these accounts have debit balances because they are reductions to sales. Accounts with balancesthat are the opposite of the normal balance are called contra accounts; hence contra revenueaccounts will have debit balances.Let's illustrate revenue accounts by assuming your company performed a service and wasimmediately paid the full amount of ETB 50,000 for the service. The debits and credits are presentedin the following general journal format:
Account NameDebitCredit50,000.00Cash50,000.00Service RevenueWhenever cash is received, the asset account Cash is debited and another account will need to becredited. Since the service was performed at the same time as the cash was received, the revenueaccount Service Revenues is credited, thus increasing its account balance.Let's illustrate how revenues are recorded when a company performs a service on credit (i.e., thecompany allows the client to pay for the service at a later date, such as 30 days from the date of theinvoice). At the time the service is performed the revenues are considered to have been earned andthey are recorded in the revenue account Service Revenues with a credit. The other accountinvolved, however, cannot be the asset Cash since cash was not received. The account to bedebited is the asset account Accounts Receivable. Assuming the amount of the service performed isETB 14,000, the entry in general journal form is:Account NameAccounts ReceivableDebitCredit14,000.0014,000.00Service RevenueAccounts Receivable is an asset account and is increased with a debit; Service Revenues isincreased with a credit.Expenses and Losses are Usually DebitedExpenses normally have debit balances that are increased with a debit entry. Since expenses areusually increasing, think "debit" when expenses are incurred. (We credit expenses only to reducethem, adjust them, or to close the expense accounts.) Examples of expense accountsinclude Salaries Expense, Wages Expense, Rent Expense, Supplies Expense, and Interest Expense. In a Taccount, their balances will be on the left side.To illustrate an expense let's assume that on June 1 your company paid ETB 8,000 to June rent.The debits and credits are shown in the following journal entry:Account NameRent ExpenseCashDebitCredit8,000.008,000.00Since cash was paid out, the asset account Cash is credited and another account needs to bedebited. Because the rent payment will be used up in the current period (the month of June) it isconsidered to be an expense, and Rent Expense is debited. If the payment was made on June 1 fora future month (for example, July) the debit would go to the asset account Prepaid Rent.
As a second example of an expense, let's assume that your hourly paid employees work the lastweek in the year but will not be paid until the first week of the next year. At the end of the year, thecompany makes an entry to record the amount the employees earned but have not been paid.Assuming the employees earned ETB 11,900 during the last week of the year, the entry in generaljournal form is:Account NameWages ExpenseDebitCredit11,900.00Wages Payable11,900.00As noted earlier, expenses are almost always debited, so we debit Wages Expense, increasing itsaccount balance. Since your company did not yet pay its employees, the Cash accountis not credited, instead, the credit is recorded in the liability account Wages Payable. A credit to aliability account increases its credit balance.To help you get more comfortable with debits and credits in accounting and bookkeeping, memorizethe following tip:Here's a TipTo increase an expense account, debit theaccountPermanent and Temporary AccountsAsset, liability, and most owner/stockholder equity accounts are referred to as permanent accounts (orreal accounts). Permanent accounts are not closed at the end of the accounting year; their balancesare automatically carried forward to the next accounting year.Temporary accounts (or nominal accounts) include all of the revenue accounts, expense accounts, theowner's drawing account, and the income summary account. Generally speaking, the balances intemporary accounts increase throughout the accounting year. At the end of the accounting year thebalances will be transferred to the owner's capital account or to a corporation's retained earningsaccount.Because the balances in the temporary accounts are transferred out of their respective accounts atthe end of the accounting year, each temporary account will have a zero balance when the nextaccounting year begins. This means that the new accounting year starts with no revenue amounts,no expense amounts, and no amount in the drawing account.By having many revenue accounts and a huge number of expense accounts, a company will be ableto report detailed information on revenues and expenses throughout the year.
Bank's Debits and CreditsWhen you hear your banker say, " credit your checking account," it means the transactionwill increase your checking account balance. Conversely, if your bank debits your account (e.g., takesa monthly service charge from your account) your checking account balance decreases.If you are new to the study of debits and credits in accounting, this may seem puzzling. After all, youlearned that debiting the Cash account in the general ledger increases its balance, yet your bank saysit is crediting your checking account to increase its balance. Similarly, you learned that crediting theCash account in the general ledger reduces its balance, yet your bank says it is debiting yourchecking account to reduce its balance.Although the above may seem contradictory, we will illustrate below that a bank's treatment of debitsand credits is indeed consistent with the basic accounting procedure that you learned. Let's look atthree transactions and consider the related journal entries from both the bank's perspective and thecompany's perspective.Transaction #1Let's say that your company receives ETB 10,000 of currency from a customer as a down paymentfor a future site cleanup service. When the money is received your company makes the followingentry:Account NameCashUnearned RevenueDebitCredit10,000.0010,000.00Because it has received cash, your company increases its Cash account with a debit of ETB 10,000.The rules of double-entry accounting require to also entering a credit of ETB 10,000 into another ofits general ledger accounts. Since the company has not yet earned the ETB 10,000, it cannot credit arevenue account. Instead, the liability account Unearned Revenues is credited because thecompany has a liability to do the work or to return the ETB 10,000. (An alternate title for theUnearned Revenues account is Customer Deposits.)Now let's say you take that ETB 10,000 to Awash Bank and deposit it into the company’s checkingaccount. Since Awash Bank is receiving cash of ETB 10,000, the bank debits its general ledgerCash account for ETB 10,000, thereby increasing the bank's assets. The rules of double-entryaccounting require the bank to also enter a credit of ETB 10,000 into another of the bank's generalledger accounts. Because the bank has not earned the ETB 10,000, it cannot credit a revenueaccount. Instead, the bank credits a liability account such as Customers' Checking Accounts toreflect the bank's obligation/liability to return the ETB 10,000 to your company on demand. In generaljournal format the bank's entry is:(Awash Bank's journal entry)
Account NameDebitCredit10,000.00CashCustomer’s checking Accounts10,000.00As the entry shows, the bank's assets increase by the debit of ETB 10,000 and the bank's liabilitiesincrease by the credit of ETB 10,000. The bank's detailed records show that the company’s checkingaccount is the specific liability that increased.Transaction #2Let's say Awash Bank receives an ETB 100,000 wire transfer on your company's behalf from aperson who owes money to the company. Two things happen at the bank: (1) The bank receivesETB 100,000, and (2) the bank records its obligation to give the money to Your Company ondemand. These two facts are entered into the bank's general ledger as follows:(Awash Bank's journal entry)Account NameDebitCredit100,000.00CashCustomer’s checking Accounts100,000.00The debit increases the bank's assets by ETB 100,000 and the credit increases the bank's liabilitiesby ETB 100,000. The bank's detailed records show that your company’s checking account is thespecific liability that increased.At the same time the ETB 100,000 wire transfer is received at the bank, The company makes thefollowing entry into its general ledger:(Your company’s journal entry)Account NameCashAccounts ReceivableDebitCredit100,000.00100,000.00As a result of collecting ETB 1,000 from one of its customers, Debris Disposal's Cash balanceincreases and its Accounts Receivable balance decreases.
Transaction #3Many banks charge a monthly fee on checking accounts. If Awash Bank decreases Your company’schecking account balance by ETB 26.00 to pay for the bank service charge, this might be itemizedon the company’s bank statement as a "debit memo." The entry in the bank's records will show thebank's liability being reduced (because the bank owes the company ETB 26 less). It also shows thatthe bank earned revenues of ETB 26 by servicing the checking account.(Awash Bank's general ledger)Account NameCustomer’s Checking AccountDebitCredit26.0026.00Service Charge RevenueOn your company's records, the entry will look like this:(Your company’s general ledger)Account NameBank Service Charge ExpenseCashDebitCredit26.0026.00The company’s cash is reduced with a credit of ETB 26 and expenses are increased with a debit ofETB 26. (If the amount of the bank's service charges is not significant a company may debit thecharge to Miscellaneous Expense.)Bank's Balance SheetAccounts such as Cash, Investment Securities, and Loans Receivable are reported as assets on thebank's balance sheet. Customers' bank accounts are reported as liabilities and include the balancesin its customers' checking and savings accounts as well as certificates of deposit. In effect, your bankstatement is just one of thousands of subsidiary records that account for millions of birr (dollars) that abank owes to its depositors.
RecapHere are some of the highlights from this explanation: Debit means left. Credit means right. Every transaction affects two accounts or more. At least one account will be debited and at least one account will be credited. The total of the amount(s) entered as debits must equal the total of the amount(s) entered ascredits. When cash is received, debit Cash. When cash is paid out, credit Cash. To increase an asset, debit the asset account.To increase a liability, credit the liability account.To increase owner's equity, credit an owner's equity account.To increase revenues, credit the revenues accountA credit to a revenue account also causes an increase in owner's equity To increase expenses, debit the expense accountA debit to an expense account also causes a decrease in owner's equity
Because every business transaction affects at least two accounts, our accounting system is known as a double-entry system. (You can refer to the company's chart of accounts to select the proper accounts. Accounts may be added to the chart of accounts when an appropriate account cannot be found.)
Objective 1: Define debit and credit. A debit is an entry on the left side of an account; a credit is an entry on the right side of an account. Objective 2: Describe the relationship between debits and credits, and the accounting equation. Assets Liabilities Owner's Equity. Left Right Debits Credits.
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Statements from a Trial Balance When a trial balance is complete, the total of all the debits must equal the total of all the credits. Income Statement: Once the trial balance is complete, the first report to make is the income statement, which is made up of only revenue and expense. Statement of Owner’s Equity: The second report to
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May 01, 2015 · balance sheet. Transactions are manually entered into the accounting record using adjusting journal entries (AJEs) which present debits before credits. Accountants may use a trial balance to summarize all accounts in debit and
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