Standard accounting practices use a system of debits and credits to track financial changes in a company’s books. This chart of accounts is usually categorized by type, and it includes assets, liabilities, revenues, expenses, losses and gains. The trick is to understand that both debits and credits must balance out: Every single transaction a business makes affects at least two different line items within the accounts chart.
Debit and Credit Examples
Debits and credits don’t necessarily directly correlate to gains and losses conceptually; they’re about the bookkeeping used. For example, adding debits increases line items such as assets, expenses and losses. Adding credits increases line items such as liabilities, revenues and gains.
For example, the purchase of a new asset for $100 is recorded as both a credit and a debit. The $100 value of that asset becomes a debit in the fixed assets line item, and the $100 cost is credited to the accounts payable line item so that it is there to pay the bill when it comes due. Within the chart of accounts, this is the correct way to record the purchase of this asset.
This doesn’t mean, however, that all entries on one side of the balance are credits, and the other side consists entirely of debits. It is, in fact, possible to see debits on the side of a revenue account.
Debit Revenue and Accounting
Debit revenue is a somewhat misleading term, as it implies receiving revenues from debits. What the term refers to is the act of posting a debit to a stream of revenue.
For example, a set of items are sold in a month, and the incoming cash earned by these sales is posted as revenue. However, three items are returned. This revenue must be debited to correct for the items that were returned. The preferable accounting term is contra accounts because they’re the opposite of the standard accounts. In this case, revenue, which is usually posted as a credit, also includes a debit.
Revenues can be debited for a number of reasons. Often accountants choose to record an overall revenue with these debits as individual line items to separately record returns, allowances or sales discounts over a given period. This way, accounting can track the financial changes related to returns or discounts over time, which helps determine business trends. For example, if there’s a large number of returns over one financial period, it may be time to look into production and determine whether there’s a problem.
Deferred Revenue and Debits
This can also happen with deferred revenue when a company chooses not to take all revenues in one accounting period. A company can choose not to take revenue immediately, but all accounting statements must follow Generally Accepted Accounting Principles (GAAP).
For example, it may be tempting for a company to defer revenue or include a number of debits against its revenues so that total revenue is lower to reduce the taxes owed. Accounting auditors look for improperly debited accounts to ensure financial bookkeeping is legitimate.
Contra Accounts and Debits
Other types of contra accounts include accumulated depreciation, which acts as a debit against the credit of an asset. These types of accounts are also often used for a company’s credit accounting; line items for things like doubtful accounts or bad debt expense cover the company’s understanding that some percentage of accounts receivable are uncollectable. These accounts may not necessarily represent solid actual transactions, but they capture a better picture of the company’s finances.