Debits and Credits(Quick Test #4 with Coaching)

In bookkeeping and accounting, it is best to think of debit as the left side of a general ledger account, or the left side of a T-account or journal entry.

Under the double-entry method, the amounts entered as debits must be equal to the amounts entered as credits. (Credit amounts are entered on the right side of a general ledger account, T-account, or journal entry.)

TIP: Do NOT think of a debit as good or bad. For example, assets are increased with a debit entry but expenses are also increased with a debit entry.

In bookkeeping and accounting, it is best to think of credit as the right side of a general ledger account, or the right side of a T-account or journal entry.

Under the double-entry method, the amounts entered as credits must be equal to the amounts entered as debits. (Debit amounts are entered on the left side of a general ledger account, T-account, or journal entry.)

TIP: Do NOT think of credit as good or bad. For example, liabilities are increased with a credit entry but revenues are also increased with a credit entry.

The preferred method for recording transactions is the double-entry system. This means that every transaction will affect two or more general ledger accounts.

To illustrate, let’s assume that a company pays monthly rent of $1,000. The account Rent Expense will be debited for $1,000 and the account Cash will be credited for $1,000. (When only one account is debited and one account is credited, the entry is referred to as a simple entry.)

If the rent of $1,000 consists of $400 for the office and $600 for the warehouse, the entry may be a debit of $400 to Office Rent Expense, a debit of $600 to Warehouse Rent Expense, and a credit to Cash for $1,000. (When an entry has more than one account being debited or more than one account being credited, it is known as a compound entry.)

Popular accounting software uses the double-entry system. However, the software may require that you enter only the account and amount to be debited. For instance, when a check is written, the software will automatically credit the Cash account and therefore you need only enter the account(s) and amount(s) to be debited.

The chart of accounts is a listing of the accounts that are available for recording transactions. The chart of accounts does not include any transaction amounts or account balances. The chart of accounts can be expanded to accommodate new types of business transactions.

The general journal is a place for recording some transactions (such as depreciation) before the amounts are posted to the general ledger accounts.

The general ledger and the trial balance include account balances.

When recording a transaction in the general journal, it is customary to first write the title of the account that is to be debited.

The account title that is to be credited is usually indented and is written on the line following the account title that is to be debited.

The process of recording a transaction in a general journal is referred to as journalizing.

After journalizing a transaction, the process of recording those amounts in the appropriate general ledger accounts is known as posting.

An asset account normally has a debit balance. This means the account balance for an asset will appear on the left side of a T-account.

For example, a company that has a positive amount of cash will have a debit balance in its general ledger account Cash. When the company receives money, the debit balance in the Cash account will be increased (with a debit entry). When the company writes a check the debit balance will be decreased (with a credit entry).

TIP: The accounting equation has asset accounts on the left side. The asset accounts will normally have their balances on the left side or debit side.

A liability account normally has a credit balance. This means the account balance for a liability will appear on the right side of a T-account.

For instance, if a company owes $9,000 to its vendors (suppliers), its general ledger account Accounts Payable should have a credit balance of $9,000. When the company buys more supplies on credit, the credit balance in Accounts Payable will be increased (with a credit entry). When the company pays one of the suppliers, the credit balance will be decreased (with a debit entry).

TIP: The accounting equation has liabilities on the right side. The liability accounts will normally have their balances on the right side or credit side.

The stockholders' equity account Common Stock is expected to have a credit balance. This means the account balance will appear on the right side of the T-account.

For instance, if a corporation had sold shares of its common stock for a total of $100,000 its general ledger account Common Stock should have a credit balance of $100,000. When the corporation issues/sells more shares of common stock, the credit balance in Common Stock will be increased (with a credit entry).

TIP: The accounting equation has stockholders' equity on the right side. The stockholders' equity accounts will normally have their balances on the right side or credit side.

The owner's equity account R. Smith, Capital is expected to have a credit balance. This means the account balance will appear on the right side of the T-account.

For instance, if R. Smith invested $25,000 into her sole proprietorship, the general ledger account R. Smith, Capital should have a credit balance of $25,000. If R. Smith invests additional money in this business, the credit balance in R. Smith, Capital will be increased (with a credit entry).

TIP: The accounting equation has owner's equity on the right side. The owner's equity account R. Smith, Capital will normally have its balance on the right side or credit side.

The normal balance for a revenue account is a credit balance. (Sales and Fees Earned are two examples.)

Revenue accounts are credited and have credit balances because revenues cause owner's equity and stockholders' equity to increase. (Recall that owner's equity and stockholders' equity appear on the right side of the accounting equation. To increase the balance on the right side, a credit is needed.)

TIP #1: Typically revenue accounts are credited.

TIP #2: If a cash sale occurs, the asset Cash is debited (because this asset increased) and therefore Sales has to be credited, due to the double-entry system.

The normal balance for an expense account is a debit balance. (Rent Expense and Interest Expense are two of perhaps hundreds of expense accounts.)

Expense accounts are debited and have debit balances because expenses cause owner's equity and stockholders' equity to decrease. (Recall that owner's equity and stockholders' equity appear on the right side of the accounting equation. To decrease the balance on the right side, a debit is needed.)

TIP #1: Typically expense accounts are debited.

TIP #2: When the monthly rent is paid, the asset Cash is credited (because this asset decreased) and therefore Rent Expense has to be debited, because of the double-entry system.

Since asset accounts normally have debit balances, a contra asset account is expected to have a credit balance.

Accumulated depreciation is a contra account for assets such as Buildings, Equipment, Fixtures, Furniture, and Vehicles. When a company depreciates these assets, Depreciation Expense is debited and Accumulated Depreciation is credited.

Since liability accounts normally have credit balances, a contra liability account is expected to have a debit balance.

Discount on Bonds Payable and Bond Issue Costs are contra accounts to the liability account Bonds Payable. Discount on Notes Payable is a contra account to the liability account Notes Payable.

Since revenue accounts normally have credit balances, a contra revenue account is expected to have a debit balance.

In addition to Sales Returns and Allowances, another example of a contra revenue account is Sales Discounts (or Early Payment Discounts).

Since owner's equity is on the right side of the accounting equation, it will normally have a credit balance. Therefore, the contra owner's equity account Owner's Draws will have a debit balance.

TIP: If the owner withdraws cash from the business, the account Cash must be credited (since this asset decreased). Therefore, the double-entry system requires that the Owner's Draws account has to be debited.

The account Retained Earnings is a stockholders' equity account. Since stockholders' equity is on the right side of the accounting equation, the normal balance for the account Retained Earnings is a credit balance. Therefore a profitable corporation is expected to have a credit balance in its account Retained Earnings.

From the list of four types of accounts, only the owner's drawing account will normally have a debit balance. The owner's drawing account is referred to as a contra owner's equity account, since owner's equity accounts normally have credit balances. (Recall that owner's equity is on the right side of the accounting equation.)

TIP: When an owner withdraws cash from the business, the account Cash is credited (since this asset is being reduced) and therefore there needs to be a debit to the owner's drawing account.

Of the three types of accounts, only the owner's capital account will normally have a credit balance.

Recall that owner's equity appears on the right side of the accounting equation. Therefore, the owner's equity accounts are expected to have credit balances.

Of the three types of accounts, only the contra asset accounts will normally have credit balances. (Two examples of contra asset accounts are Accumulated Depreciation and Allowance for Doubtful Accounts.)

Recall that asset accounts appear on the left side of the accounting equation. Since asset accounts are expected to have debit balances the contra asset accounts are expected to have credit balances.

Of the three types of accounts, only the contra revenue accounts will normally have debit balances. (Two examples of contra revenue accounts are Sales Discounts and Sales Returns and Allowances. These accounts reduce a company's gross sales to its net sales.)

Recall that revenue accounts will cause owner's equity or stockholders' equity to increase. Since the owners' equity and stockholders' equity are on the right side of the accounting equation, they are increased with credits. Since a contra revenue account causes a decrease in revenues and equity, a contra revenue account must have a debit balance.

When a company pays an invoice (writes a check, etc.) the company credits the account Cash, since this company asset is being reduced.

TIP: Since many transactions involve the account Cash, it is helpful to memorize that receiving cash requires a debit to the Cash account, and that paying cash requires a credit to the Cash account.

When a company incurs an ordinary repair, the amount is debited to an expense account such as Computer Repair Expense.

The repair or maintenance of equipment is considered to be an expense, since the equipment is not becoming more than what it was before the repair work.

When a company makes a significant improvement (such as adding a hydraulic lift to one of its trucks), the amount is recorded in the asset account Trucks. The cost of the improvement will be depreciated over the remaining useful life of the truck.

If there is a repair of an existing hydraulic lift on a truck, the amount should be expensed immediately. The reason is there is no improvement. The repair is merely returning the lift to its previous operating condition.

The routine accounting entry for depreciation includes a debit to Depreciation Expense and a credit to Accumulated Depreciation.

Accumulated Depreciation of Equipment is a contra asset account associated with the asset account Equipment.

R. Smith, Drawing is viewed as a temporary account since it is closed to the owner's capital account at the end of each accounting year.

The other three accounts listed are permanent accounts since they are not closed at the end of the accounting year.

TIP #1: All of the income statement accounts (revenues, expenses, gains, and losses) are temporary accounts since they are closed at the end of the accounting year.

TIP #2: The balance sheet accounts, except for the owner's drawing account, are considered to be permanent accounts since they are not routinely closed at the end of the accounting year.

The debits for recording the monthly mortgage payment will be: Interest Expense (or Mortgage Interest Expense) $375; and Mortgage Loan Payable $625.

The $625 debit is a partial repayment of the principal amount that was borrowed. Hence, the $675 debit reduces the principal amount still owed to the lender.

Since the banquet hall business will not earn the $1,000 until February 27, the accrual method requires that the $1,000 be deferred from reporting it as revenue until February 27. This means that on December 31, the business will debit Cash for $1,000 and will credit a liability account such as Deferred Rental Deposits for $1,000.

The liability account communicates to the readers of the December 31 balance sheet that the business has an obligation to provide the future use of the hall or to return the customer's deposit.

The actual cost of the real estate is $412,000. This amount must be divided between land and building since only the building's cost can be depreciated.

The basis for dividing the actual cost of $412,000 will be the appraised amounts. The appraisal indicates that the land is $100,000 of the $400,000 total or 25% of the total appraised value. The appraisal also indicates that the building is $300,000 of the $400,000 total or 75% of the total appraised value.

We must adhere to the cost principle by recording the actual total cost of $412,000, but we use the appraised amounts to allocate (divide up) the $412,000.

Land: 25% of $412,000 = $103,000;
Building: 75% of $412,000 = $309,000

The trial balance is an internal document which lists the general ledger account balances to show that the general ledger accounts have debits equal to credits.

With today's accounting software, it is nearly certain that the general ledger accounts will have debits equal to credits. However, this is not the case with a manual accounting system.