Debits and Credits in Accounting Explained (2024)

Debits and credits are fundamental to accounting. They help track every transaction a business makes.

Debit VS Credit Accounting

When a business buys supplies or receives payment, the transaction splits into two parts: a debit in one account and a credit in another. This process is called double-entry accounting.

💡In accounting, every transaction will have debits and credits and at least two accounts will be affected.

Let’s first learn the difference between debit and credit in accounting.

What is a Debit

In double-entry accounting, a debit is the destination where money is flowing into. Think of it as the account that receives money.

What is a Credit

A credit is the source where money is coming from. It shows which account the money is leaving.

Just think of it as a bank transfer.When you send someone money, it comes out of your bank account (the source) and it goes into their account (the destination).

In accounting, instead of these piggy banks, we use T-accounts.

Every account has it’s own T. The left side of the T is where the debits go. Credits go on the right side.

How Debits and Credits Work

• Two Accounts Affected: Every transaction impacts at least two accounts. For example, if a company buys office supplies, it debits the Supplies account and credits the Cash account.
• T-Accounts: Each account has a T-account. Debits go on the left side, and credits go on the right side.
• Balancing Transactions: For every transaction, the total amount of debits must always equal the total amount of credits. This balance keeps the financial records accurate.

❗Debit and credit do not mean plus or minus.It literally just means debit means left, credit means right.

Next, let’s figure out the balance in a T-account.

What is the Balance of an Account

The account balance is simply the total amount in that account after considering all debits and credits.

So, let’s say we have these two accounts visualized at T’s.

Then, we record some transactions to them.

First, account number one gets a debit of 500, and account number two gets a credit of 500.

For the second transaction, account number two gets a debit of 100 and account number one gets a credit of 100.

With that, we successfully applied the first two rules of debit and credit. We put debits on the left side of the accounts, credits on the right side.

And, for each transaction, the total of debit and credit was the same, so far so good.

Understanding Account Balances

Now we calculate the balance for each account. We add the amounts on the debit and credit side for each account.

• Account#1 has 500 on the debit side and 100 on the credit side.

• We deduct the smaller sum of credits from the bigger total of debits which gives us 400.

In accounting, we call this a debit balance of 400.

For Account #2, it’s the opposite.It has a credit total of 500 and total debits are 100.Again, we deduct the smaller one from the bigger one, account number two has a credit balance of 400.

Let’s add two more transactions:

• One that adds another debit of 50 to Account #1
• One more with a debit of 100 going to Account #2

Let’s just say the credits for these transactions go to different accounts.We don’t need to worry about these for now.

New Balances:

Account#1:

• New Debit Total: $500 + $50 = $550
• Balance: $550 (debits) – $100 (credits) = $450 (Debit Balance)

Account#2:

• New Debit Total: $100 + $100 = $200
• Balance: $500 (credits) – $200 (debits) = $300 (Credit Balance)

Both received a debit, but one account increases while the other one decreases.They are behaving differently.

Key Rule

It depends on the account if a debit or a credit increases the balance or if it decreases it.And, that’s really the secret to understanding debit and credit.

We saw this in our example. The balance of Account#1 goes up with the debit. The balance of Account#2 goes down.

Two Groups to Remember

You may ask, “Well how do you know which one it is?” Fortunately, there are only two groups to remember.

DEBITS

• Assets – That’s the resources the company owns and uses, like buildings, machines, equipment and so on.
• Dividends – That’s when the company distributes its profit and cash to the owners.
• Expenses – That’s money we pay for goods or services the business purchased.

All accounts in this group are debits, which means that their balance will usually be a debit. Therefore, the total of these accounts willincreasewhen they get another debit and willdecreasewith they get another credit.

So, account number one in our previous example would be in this group.

CREDITS

• LIABILITIES – Money we still owe to others, like to the bank, to suppliers or to the IRS.
• OWNER’S EQUITY – Money the owners of the company put into the business.
• REVENUE – Money we receive for sales to our customers.

All accounts in this group are credits which means that their balance will usually be a credit.

Therefore, the total of these accounts willincreasewhen they get another credit and willdecreasewhen they get another debit.

So, account number two in our previous example would be in this group.

And, that’s rule number three. It’s really important that you memorize this because to record any transaction, you have to answer two questions.

Which accounts are affected? Did accounts go up or down?

In order to answer question number two, you need to understand if an account is a debit or a credit account.

ADEx LER: How to Remember Debits and Credits

If you have trouble remembering this, just think ofADEx LER:AccountantsDon’tExpectLowEarningRates.

Assets,Dividends,Expenses,Liabilities,Equity, andRevenue.

ADEx are Debits.

The balance of these accounts increases with debits and decreases with credits.

So, let’s take cash for example. Cash is an asset. So, it resides on the debit side of our equation.

When you take money out of your account to pay for something you reduce your cash balance.

Remember our rule; the balance on the debit side increases with debit and decreases with credit.

So, do we debit or credit the cash account? We credit it because we reduce it.

LER are Credits.

The balance of these accounts increases with credits and decreases with debits.

Take a loan, for example, which is a liability.

When you take out a higher loan, you credit the loan account.

When you pay back a loan, what do you do? You debit the loan account, which will reduce its balance.

So, that’s really all there is to it.

All you must remember is “AccountantsDon’tExpectLowEarningRates”.

ADEx LER:Assets,Dividends,Expenses,Liabilities,Equity, andRevenue.

This will help you determine debit and credit accounts.

Just practice it and it’s eventually going to become second nature to you. In the end, you’re not even going to have to think about it anymore.

How Does a Bank Account Debit Card Work

Many people find debit cards confusing when they think about debits and credits. Here’s why.

Bank Terminology Explained

When you deposit money into your account, the bank credits it. When you withdraw money, the bank debits your account.

A debit card allows you to access your funds and withdraw money. This seems opposite to what we’ve learned about debits vs credits in accounting.

Understanding the Difference

Cash is an asset. According to ADEx LER, assets increase with a debit and decrease with a credit. So, when you add money to your account, you should debit it. When you take money out, you should credit it.

Why It Seems Backward

The confusion arises because banks look at transactions from their perspective, not yours.

From the Bank’s Point of View

• Deposits: When you deposit money, it becomes a liability for the bank because they owe it back to you.
  • Bank’s Entry: They credit your account to increase their liability.
• Withdrawals: When you withdraw money, the bank’s liability decreases.
  • Bank’s Entry: They debit your account to reduce their liability.

Example

You Deposit $500:

• Your View: Debit (increase) your Cash account.
• Bank’s View: Credit (increase) their Liability (your account).
  • According toADEx LER, liabilities are on the credit side of the equation. And, to increase a liability, the bank will have to credit it.

You Withdraw $100:

• Your View: Credit (decrease) your Cash account.
• Bank’s View: Debit (decrease) their Liability (your account).
  • The bank’s liability decreases which is whey they will debit the account.

Why is it Called a Debit Card?

When you use your debit card, you’re taking money out of your account, which the bank sees as reducing their liability to you. They debit your account, hence the name “debit card.”

How Credit Cards Work?

Credit cards work differently from debit cards. When you get a credit card, the bank or card provider offers you a line of credit. This means they allow you to borrow money up to a certain limit to make purchases.

Credit Cards Combine Services

• Payment Services: You use the credit card to pay for goods and services.
• Extension of Credit: You borrow money from the bank or card provider to make these payments.

Interest Charges

If you don’t pay off your balance in full each month, you’ll be charged interest on the remaining amount. Credit card interest rates are usually very high.

In addition, credit cards may offer additional insurance on purchases or make it easier to request a refund or a return.

But the main purpose of a credit card is to provide a credit limit you can use.

I hope this was helpful to avoid confusion.

Please just stick to the definitions of debits and credits and always rememberADEx LERand you’re going to be fine.

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Enhance your learning experience by downloading our practice file. Practice the techniques discussed in real-time and master how to record debits and credits with hands-on examples. Download the workbook here and start applying what you’ve learned directly in Excel.