Accounting Transactions:
Rules of Debits and Credits
In all fairness, debits and credits are not that difficult to understand, it is simply that due to the nature of the material debits and credits often refer to, people instinctively shy away from explanations and knowledge. Take just a minute, and lay aside any prejudices to accounting material that you may have, and let me show you how truly simple, yet amazing this system can be.
Every transaction in accounting is either a debit or a credit. How simple is that concept? Everything you record in a financial manner (in other words that has a dollar value) is either a debit or a credit. The abbreviations for debit and credit are DR and CR, respectively. Even the abbreviations are quite simple. The difficulty comes in determining which type of transaction you are recording.
Debits are a component of an accounting transaction that will increase assets and decrease liabilities and equity. Credits are a component of an accounting transaction that will increase liabilities and equity and decrease assets.
Maybe we can put this into a simpler format:
- Credits increase liabilities and equity; credits decrease assets.
- Debits decrease liabilities and equity; debits increase assets.
If you will simply make yourself a chart, with the information above, you should easily be able to discern which transactions are credits or debits for which accounts.
That being said, let's take a look at the basic rules when recording debits and credits. For each transaction, there are at least two accounts affected, one with a debit and one with a credit. Every financial transaction credits one account and debits another. It is only because of the distaste for accounting that many individuals have, that we find it so difficult to grasp this idea. We have no trouble understanding yin and yang, give and take, action and reaction, and credits and debits are no different; it just so happens they apply to accounting!
Even if you fail to realize the real life application of debits and credits, we use the system in almost every aspect of our lives. This is why I have such trouble in comprehending why readers do not readily grasp the debit/credit concept. The rules are simple: for every debit, there is a credit. The concept is the same as for actions and reactions; with an exception: actions/reactions refer to energy, and debits/credits refer to finances. When you make a purchase at the local grocery, you credit your cash, and debit your food supply. You decreased your cash (always an asset); therefore the decrease is recorded as a credit; that leaves the increase in your food supply to be recorded as a debit. If necessary, read this last paragraph once more, and try to view your daily events in a financial light. As for the accounting professionals, every day is a debit or credit, an exchange of value between assets and liabilities.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.