When you hear an accountant talk about debits and credits, they’re usually not talking about a debit card or credit card from their local bank. Debits and credits, in the accounting sense, mean something a bit different. They serve as a means to record accounting transactions, and these entries form the basis of something known as double-entry accounting.
Double-entry accounting was first used in the 1400s, and an Italian mathematician named Luca Pacioli wrote and published a book on the subject in 1494. The book was illustrated by his friend Leonardo Da Vinci and described the accounting system by covering topics such as accounting journals, the income statement, balance sheet, double-entry accounting and many other concepts that formed the basis of the accounting systems still in use to this day.
Although many in the field consider Pacioli the “father of accounting,” some form of his double entry system had been in use for many years before Pacioli’s book was published, although no one knows how or when the accounting system first came to be.
What Is a Debit and Credit?
The system of accounting for business transactions, also referred to as bookkeeping, works on the basis that each new transaction a business makes causes two different changes in the company's financial state. Accountants use debits and credits to record transactions to two or more bookkeeping accounts, using a specified set of debit and credit rules.
Outside of the accounting world, the word credit typically has a positive connotation, such as extra credit work, or getting credit for trying hard. For accountants, however, the only thing debit and credit represent are the left and right sides of a T account, which are used in the following ways.
When creating and entering an accounting transaction, you can use debits and credits to determine how the dollars coming in or out of the company affect the involved accounts. You might input them into a software-based accounting system, entering the data into an accounting journal, known as making a journal entry. The accounting system would be set up to post these journal entries to the company’s main accounting record, called the general ledger.
You will likely see debit and credit abbreviated as dr and cr. No single explanation seems to exist for these abbreviations’ origin, but some speculate that they stand for debit record and credit record. Others look back to the historical accounting and say that they stand for the Latin words debere ad credere.
A credit signifies a transaction entry made on the right side of a two-column account record, while a debit signifies a transaction entry made on the left side. These account records, called “T accounts,” earned their name because an accountant draws T shapes on paper, and puts the account names being used at the top, such as “cash” on one T and “office supplies” on the other.
The left side of each T account is always used for debit entries, and the right side of the T is always used for credit entries. T accounts are often used as a basic training tool to help students understand how double-entry accounting works. The T accounts allow you to write out on paper how each side of a transaction is recorded into the various accounts of the general ledger. This method does not work for single entry accounting.
These T accounts are a graphical way to represent an account in the general ledger, which is the main storage record for all of a company’s accounting transactions. Many accountants write out accounting entries on paper using T-account diagrams, as a way to double-check a transaction and make sure that the debits and credits total to zero and keep the accounting equation balanced.
A complex accounting transaction may require entries recorded to a number of different accounts, necessitating the use of several handwritten T accounts to write up and check the transaction. Again, this serves as an effective way to verify that all of the transaction’s debits and credits balance out to zero and that the transaction contains no errors before inputting the entries to an accounting system’s general ledger.
For regular daily accounting work, an accountant would create journal entries directly into accounting software, rather than using T accounts.
What Is a Credit Balance?
A credit balance refers to the dollar balance in a certain account, but it’s not quite that simple. When a company sets up its general ledger, it creates a chart of accounts. This is a list of each account the company uses to record financial transactions, and the data in these accounts ultimately flows into the company’s financial statements.
Each account has a “normal” balance; in other words, it typically holds either a debit or credit balance. For example, the sales account typically holds a positive balance, which would be a credit balance. To increase this account, you would make a credit entry. If your sales account held a debit or negative balance, this would be an important red flag to investigate. Some accounts behave oppositely, and a credit balance would be negative, such as a credit entry to the cash account reduces the cash account balance.
All of the accounts, whether debit or credit-based, adhere to a principle called the accounting equation:
Accounting equation: Assets = Liabilities + owners’ equity
This fundamental equation underlies the whole double-entry accounting system, and when an entry affects an asset account, it must also affect either a liability or owners’ equity account as well, to keep the equation in balance. The debit and credit double-entry system is the mechanism that helps to keep the equation in balance.
Accounts with a normal credit balance get increased when a credit entry has been made. Revenue coming into the company, or gains, such as a gain on the sale of assets such as used equipment sold off by the firm, are income statement accounts and they get recorded as an increase by using a credit entry. On the balance sheet, a credit entry would increase liability and owners’ equity accounts.
What Is a Debit Balance?
Accounts with a normal debit balance include assets on the balance sheet and expense accounts on the income statement. This means that a debit entry increases the balance of these accounts. Expense accounts include wages expense, interest expense, supplies expense and other office-related costs.
It’s not always easy to keep debits and credits straight, but you can think of debiting an expense account every time you incur an expense.
Is a Debit Balance Positive or Negative?
The quick answer is, it depends. The normal balance for an asset account is a debit balance, and also a positive amount. For example, the cash account on the balance sheet has a normal, positive debit balance if a company has cash in the bank.
On the other hand, when you consider expense accounts on the income statement, these accounts also have a normal debit balance, but instead, it represents a negative number or money paid out by the firm.
What Does It Mean to Credit an Amount?
When you credit an amount, you make an entry to an account in the form of a credit, as opposed to a debit. If you credit a liability account, you’ll increase its balance. For example, if you credit $100 to accounts payable because you extended credit to a customer, you’ve increased the balance of your accounts payable account. On the income statement, if you credit your sales revenue account, you have also increased it since the sales account has a normal credit balance, and credit entries increase it.
If you make a credit entry to an account with a normal debit balance, which includes asset accounts on the balance sheet and expense accounts on the income statement, this means you’re reducing the balance of the account. For example, say you paid $50 cash to buy supplies. You would reduce the cash account by making a credit entry since cash is a normal debit balance account.
What Are Contra Accounts?
Contra accounts are general ledger accounts which work the opposite of the normal debit and credit accounts. For example, a contra-asset account has a normal credit balance, where a regular asset account has a normal debit balance. Contra accounts work to offset regular accounts, and they allow the original balance to reside in accounting records while also reporting on the offsetting amounts.
For example, the accounts receivable account has a contra account called “allowance for doubtful accounts.” The balance in the accounts receivable account represents customer bills that have been issued but not yet been paid. The allowance for doubtful accounts represents an amount for which the company thinks it will not ever see payment. This amount is often a small percentage of the total accounts receivable balance.
Say the accounts receivable account has a normal debit balance of $30,000. The allowance for doubtful accounts has a normal credit balance of $2,000. These two accounts offset each other, leaving with you with a net of $28,000 in accounts receivable. Using these two accounts allows you to still report the original accounts receivable amounts and be able to show it being offset by the $2,000 that you know you'll probably never likely receive, giving you the amount that will turn into cash.
Other contra accounts exist, and they always have a partner. For example, accumulated depreciation is a contra asset account, and it's tied to the fixed asset plant and equipment account. The sales account has a contra revenue account called returns and allowances.
Using the Trial Balance
Accountants assemble a report called a trial balance when using a double-entry accounting system to check that all entries have been made correctly. The trial balance lists every account in the company’s general ledger and each account’s balance. When using double-entry accounting, you must make a debit entry to offset every credit entry, and vice-versa. If you receive cash for the sale of goods, you will increase the sales account with a credit entry, and you would also increase your cash account, using a credit entry. All debits and credits must directly offset each other.
When you look at a trial balance report, all entries should offset each other so that the report has a balance of zero. If the trial balance has any other total, an incorrect or incomplete entry has been made and must be fixed.
Some errors may not be discoverable by looking at a trial balance, for example, if debits and credits offset each other but have been made into the wrong accounts. If you neglect to enter a transaction at all, you won’t catch this error by looking at a trial balance. Additionally, if different debit and credit errors have been made and they just happen to offset each other numerically, they won’t be detected on a trial balance.