AccountingCoach @ presents: Debits and CreditsDebits and Credits JE Debits and credits are similar to the words used in Italy more than 500 years ago when recording business transactions. Today, we continue to use these terms. Debit is used to indicate left. Credit is used to indicate right. Debit means left or left-side. Credit means right or right-side.Note Bookkeepers and accountants store transaction amounts in a record referred to as an account. Accountants will likely use hundreds of accounts for each business or other organization. A listing of the accounts used in a business is known as a chart of accounts. The chart of accounts can be expanded as the need arises. Accounts that contain amounts are contained in the company's general ledger. Hence, the accounts are often referred to as general ledger accounts. Accounts are used to sort, store, and retrieve amounts. Achart of accounts is a listing of the accounts available for use. The accounts with amounts are found in the general ledger.Debits and Credits JRE The accounts used in a business are classified or categorized as follows: Current assets: cash, accounts receivable, inventory, prepaid expenses Noncurrent (or long-term) assets: land, buildings, equipment, vehicles Current liabilities: loans payable, accounts payable, customer deposits Noncurrent (or long-term) liabilities: bonds payable, loans payable Owner's (or stockholders’) equity: owner's capital, draws Revenues from operations: sales, fees earned Expenses from operations: cost of goods sold, salaries, advertising Other revenues and gains: investment income, gain on sale of assets Other expenses and losses: interest expense, loss on sale of assetsee ekecelcm 4 of 55 Note The asset, liability, and owner's equity account balances are reported on the financial statement known as the balance sheet or the statement of financial position. The outline of the balance sheet is the accounting equation: assets = liabilities + owner's equity, Both the balance sheet and the accounting equation must be in balance. The balance sheet and accounting equation must always be in balance: Assets = Liabill Ss + Owner's EquityThe revenues, expenses, gains and losses are reported on the income statement (or statement of eamings or profit and loss statement). The combination or net of revenues, expenses, gains and losses is the company's net income. The income statement reports the following amounts: Revenues - Expenses + Gains - Losses = Net Income NoteThe net income reported on the income statement causes the owner's equity on the balance sheet to change. That also means that revenues and gains will cause an increase in owner's equity, while expenses and losses will cause a decrease in owner's equity. Revenues, gains, and net income cause the owner's equity to increase. Expenses, losses, and a net loss cause the owner's equity to decrease. Note The connection between the income statement and the balance sheet is an important reason why the balance sheet and the accounting equation will remain in balance.Lr and Credi 7 of 55 Another reason why the accounting equation and the balance sheet will remain in balance is the procedure known as double-entry. Double-entry requires that every transaction will involve two (or more) accounts. Double-entry requires that two accounts or more are involved in every transaction. NoteDebits and Credits [RT Example Here's an example. If Amy Loy invests $5,000 of her personal cash in her new sole proprietorship Loy Company, this transaction will involve the business asset Cash and the owner equity account Amy Loy, Capital. The balance sheet and the accounting equation for Loy Company will show: Assets = Liabilities + Owner's Equity $5,000 = 0 + $ 5,000PCE Teka Sy 9 of 55 Double-entry is also associated with the debits and credits documented more than 500 years ago. As a result, there are actually two requirements: 1. Two accounts are involved, and 2. One account must have the amount entered on the left or debit side, and one account must have the amount entered on the right or credit side. The amount of the debits = the amount of the credits. NoteDebits and Credits iM The format of accounts will vary with each company's software. Here's one example: Account number: Account name: Date Description Debit Credit BalanceDebits and Credits i5 For learning our debits and credits, we will use the format known as a T-account: Account name Debits CreditsDebits and Credits iE Since each transaction will involve a minimum of two accounts, we will present two T-accounts when discussing each transaction. Account name Account name Debits Credits Debits CreditsDebits and Credits RIUs Note Typically, the asset account Cash has a large volume of activity. Ifa business transaction increases a company's cash, the Cash account is debited. In other words, when cash is. received, a debit is entered in the account Cash. When a company pays cash, a credit is entered in the Cash account. When cash is received, debit the account Cash. When cash is paid, credit the account Cash.PCE re Rey eam 14 of 55 Here's a picture of the T-account for Cash: Debit Credit Increases the Decreases the balance balance Cash received | Cash paid Deposits made Checks writtenDebits and Credi 15 of 55 Note To increase the balance in any asset account is the same as the Cash account: debit an asset account to increase its balance, and credit an asset account to decrease its balance. We also expect the balance in an asset account to be a debit balance. In other words, in a T-account, we expect to see the balance on the left side of the account. Debit an asset account to increase its balance. Credit an asset account to decrease its balance. Asset accounts usually have a debit, or left-side, balance.Debits and Credits EDT ss Another way to remember that asset accounts usually have a debit balance is to think of the accounting equation: Assets Ss + Owner's Equity Assets appear on the left side of the accounting equation and we expect that the balances in the asset accounts will also appear on the left side of the asset accountsPCE eRe 17 of 5S Transaction #1. Let's revisit our earlier example, where Amy Loy invested $5,000 of her personal cash in her new sole proprietorship, Loy Company. Since the company is receiving cash of $5,000, the asset Cash will have to be debited, and a second account will have to be credited for $5,000. Cash 2? #1 5,000 5,000 #1Pee ekecelcm 18 of 55 The next step is to identify the name of the account that is to be credited. In this example, the account to be credited is Amy Loy, Capital: Cash Amy Loy, Capital #1 5,000 5,000 #1 From these T-accounts we see that the owner equity account Amy Loy, Capital was credited in order to increase its balance from zero to $5,000. This is also consistent with the accounting equation which shows owner's equity on the right side: Assets =Peer Rey eam 19 of 5S Transaction #2. Let's assume that Loy Company also borrows $2,000 and the amount is deposited into its checking account. The two accounts involved are Cash and Loans Payable. Loans Payable isa liability account and is increased with a credit entry as shown here: Cash Loans Payable #2 2,000 2,000 #2 Notice that Loans Payable has its balance on the right side, or credit side, similar to the position of liabilities in the accounting equation. Assets = Liabilities + Owner's EquityIn addition to every transaction having debits equal to credits, the balances in the general ledger accounts must have the total of the debit balances equal to the total of the credit balances. A trial balance is a listing of all of the account balances in the general ledger and the total of each of the columns of amounts. The column totals must be equal. Debit Credit Balances Balances Column totals are equalPCE eRe 21 of 5S Transaction #3. Let's assume that the third transaction involves paying $800 for a computer. As we know, when cash is paid (or a check is written) the Cash account is credited. The second account will need to have a debit of $800. In this example, the second account is the asset Office Equipment. Here's the entry in T-account format: Cash Office Equipment | 800 #3 #8 800Debits and Credits P25 If we look into the Cash account, we will see the following activity and the resulting balance of $6,200: Cash #1 5,000 #2 2,000 800 #3 Balance 6,200Debits and Credits PAum} The trial balance after the third transaction will report the following amounts: Loy Company Trial Balance After Three Transactions Debit Credit Balances Balances Cash 6,200 Office Equipment 800 Totalsie ekeel cme 24 of 55 The balance sheet and the accounting equation for Loy Company after the third transaction will report the following totals: Liabilities + Owner's Equity $2,000 + $5,000 Assets $7,000 = ExampleDebits and Credits Pots} Transaction #4. Let's assume that Loy Company is going to repay $500 of its loan. In other words, Loy will reduce its asset Cash and will reduce its liability Loans Payable. Recall that Cash and other assets will be reduced with a credit. To reduce the credit balance in a liability account such as Loans Payable, a debit must be entered into the liability account. In T-account format, here is Loy company’s entry to repay $500 of its loan: Cash Loans Payable | 500 #4 #4 500Debits and Credits Oli Here are the two accounts showing all of the activity and their balances after the $500 payment is recorded: Cash Loans Payable #1 5,000 2,000 #2 #2 2,000 800 6,200 500 500 Balance 5,700 1,500 BalanceDebits and Credits Pagg} The trial balance after the fourth transaction will report the following amounts: Loy Company Trial Balance After Four Transactions Debit Credit Balances Balances Cash 5,700 Office Equipment 800 Totalsieee Reem 28 of 55 The balance sheet and the accounting equation for Loy Company after the fourth transaction will report the following: Liabilities + Owner's Equity $1,500 + $5,000 Assets $6,500 = Examplefee eke ceca 29 of 55 Revenues Revenues are amounts earned when a company delivers products or services to customers. Sometimes their revenues are referred to as sales or sales revenues. Companies that provide services might refer to their revenue as service revenues.Example Revenues are recorded in temporary revenue accounts and the amounts will be reported on the income statement, The revenue accounts are temporary because the amounts are stored there only temporarily—tater they will be transferred to the owner's equity account. This means that revenues will be reported on the income statement and will also increase owner's equity and assets. For example, if a sole proprietorship performs a service for $100, the accounting will change as follows: Assets = Liabilities + Owner's Equity $100 0 + $100 The assets increase because the company will have either received cash or its accounts receivable will have increased.Pee ekecelcm 31 of 55 Under the accrual method of accounting, revenues are reported on the income statement in the period in which they are earned, and this is usually the period in which they are delivered For example, if Loy Corporation receives an order on May 29 for goods or services that will be delivered on June 4 and the customer is expected to pay on July 5, the sale is reported as of June 4. (Under the accrual method of accounting, the receipt of cash is not a requirement for reporting revenues.)32 of 55 Transaction #5. (On June 4, Loy Company delivers services at the agreed-upon amount of $100 and the customer pays cash for the services. The two accounts involved are the balance sheet asset account Cash and the income statement account Service Revenues. Since the asset Cash is increasing, we need to debit Cash for $100. This means that the other account, Service Revenues, will need to be credited. A credit to Service Revenues is logical because revenues cause the owner's equity to increase. (Recall that owner's equity is on the right side, or credit side, of the accounting equation.) Cash Service Revenues #5 100 100 #5Debits and Credi 33 of 55 The trial balance after the fifth transaction will report the following amounts: Loy Company Trial Balance ‘Aftor Five Transactions Accounts Cash Office Equipment Loans Payable Amy Loy, Capital Sorvice Revenues Totals Notice that the temporary account Service Revenues is shown below the owner's equity account Amy Loy, Capital. The Service Revenues account is used to keep a separate record of the revenues for the year. Once the year is completed, the amounts in the revenue accounts will be transferred to Amy Loy, Capitaltee Tire Rey slam 34 of 5S In terms of the accounting equation and the balance sheet, the amounts after five transactions are: Liabilities + Owner's Equity $1,500 + $5,100 Assets $6,600 = ExamplePCE Tre Rey elm 35 of 55 Transaction #6. On June 10, Loy Company delivers $700 of services and allows the customer to pay in 30 days. The two accounts involved are the asset account Accounts Receivable and the temporary income statement account Service Revenues. Here is the transaction to be recorded on June 10: Accounts Receivable Service Revenues #6 700 700 #6Debits and Credits FSi The effect of the June 10 transaction on the balance sheet and the accounting equation is: Assets = Liabilities + Owner's Equity $700 = 0 a $700 ExampleDebits and Credits yas) The trial balance after the sixth transaction will report the following amounts: Loy Company Trial Balance After Six Transactions Debit Credit Accounts Balances Balances Cash 5,800 700 ‘Accounts Receivable Office Equipment 800Debits and Credits FE In terms of the accounting equation and the balance sheet, the amounts after five transactions are: Assets Liabilities + Owner's Equity $7,300 = $1,500 + $5,800 ExampleDebits and Credits Keg} Expenses Expenses are costs that a company has used up in order to earn the revenues. An example is the cost of goods sold or commissions expense. If this matching is not obvious, costs are reported on the income statement in the period in which they expire. An example of this is depreciation on equipment. Lastly, if we cannot measure any future value, costs are reported in the period in which they occur. Examples are salaries of office employees and advertising.Example Expenses are recorded in temporary accounts and those amounts will be reported on the income statement. The expense accounts are temporary because they will be transferred to the owner's equity account after the year ends. This means that expenses will be reported not only on the income statement but will decrease owner's equity and will either decrease assets or will increase liabilities, which are reported on the balance sheet. Expenses are debited, because we are decreasing owner's equity, which is expected to have a credit balance. (Recall that owner's equity is on the right or credit side of the accounting equation.) If we assume that a $900 expense occurs and the company has 20 days in which to pay the supplier, the balance sheet and accounting equation are affected when the expense occurs: Assets 0 Liabilities + Owner's Equity +$900 + - $900 The liabilities increase because the company will have an obligation to pay the supplier or vendor.Debits and Credits Fai Transaction #7. On June 25 and 26, Loy Company runs ads on the local radio station and will have to pay by July 10. The cost of the ads is $900. Since accountants cannot measure the future benefit of ads, the entire $900 must be expensed in June. Here is the accounting entry in T-account format: Advertising Expense Accounts Payable #7 900 900 #7 Note that under the accrual method of accounting, the expense is reported when the expense and liability occur—not when the cash payment is made.Debits and Credits [VJ s3 After Transaction 7, the trial balance will report the following amounts: Loy Company Trial Balance After Seven Transactions: Debit Credit Accounts Balances Balances Cash 5,800 Accounts Receivable 700 Office Equipment 800 Totals 8,200 200tee Tire Rey eam 43 of 55 In terms of the accounting equation and the balance sheet, the amounts after seven transactions are: Liabilities + Owner's Equity $2,400 + $4,900 Assets $7,300 = Example44 of 55 Collection of Accounts Receivable When a company collects some of its accounts receivable, there is both an increase and a decrease in assets. Under the accrual method of accounting, there is no new revenue being earned. As a result there will be no change in the total amount of assets, no change in owner's equity, and no effect on the income statement. We will see this illustrated in the following transactionPeer Rey eae 45 of 5S Transaction #8. ‘On July 9, Loy Company receives $700 from its customer who had received services on credit on June 10. (See Transaction 6.) The July 9 transaction in T-account format is: Cash Accounts Receivable #8 700 700 #8 Note that under the accrual method of accounting, the collection of accounts receivable does not affect a revenue account. In other words, the receipt of cash is different from earning revenues.Debits and Credits FSi In terms of the accounting equation and balance sheet, the transaction has the following effect Assets = Liabilities + Owner's Equity +$700 = Oo a 0 - $700 Example The above equation reflects that one asset Cash increased by $700, while another asset Accounts Receivable decreased by $700.Debits and Credits [yas-3 After Transaction 8, the trial balance will report the following amounts: Loy Company Trial Balance After Eight Transactions Debit Credit Balances Balances: Cash 6,500 Office Equipment 800 Totals 8,200Debits and Credits ZUIss> In terms of the accounting equation and the balance sheet, the totals after eight transactions are the same as they were after seven transactions: Assets Liabilities + Owner's Equity $7,300 = $2400 + $4,900 ExampleDebits and Credits ZUIs) Payment of Accounts Payable When a company pays some of its accounts payable, there is a decrease in assets anda decrease in liabilities. Under the accrual method of accounting, there is no new expense incurred and therefore no effect on net income or owner's equity. In other words, the payment of cash does not mean there is expense. An expenditure is not necessarily an expense.Debits and Credits UKE Transaction #9. On July 10, Loy Company pays $900 for the ads described in Transaction 7. The July 10 payment in T-account format is: Cash Accounts Payable | 900 #9 #9 900Debits and Credits XE In terms of the accounting equation and balance sheet, the transaction has the following effect: Liabilities + Owner's Equity -$900 + 0 Assets -$900 = Exampleieee keel Me 52 of 55 After Transaction 9, the trial balance will report the following amounts: Loy Company Trial Balance After Nine Transactions Debit Credit Balances Balances Cash 5,600 Office Equipment 800 Totals 8,200 8,200Debits and Credits XTi The totals in the accounting equation and the balance sheet after the ninth transaction are: Assets = Liabilities + Owner's Equity $6,400 = $1,500 + $4,900 Exampletee Tire Re elim 54 of 55 RECAP OF DEBITS AND CREDITS Debit means left. Credit means right. Assets are expected to have debit balances. Liabilities are expected to have credit balances. The owner's equity capital account is expected to have a credit balance. The stockholder's equity accounts are expected to have credit balances. When a company receives money, it debits Cash (and it must also credit another account, such as Accounts Receivable). When a company writes a check, it credits Cash (and it must also debit another account, such as Accounts Payable).Debits and Credits ty) RECAP OF DEBITS AND CREDITS Expenses should be debited (because expenses reduce owner's equity) and another account must be credited. Revenues should be credited (because revenues increase owner's equity) and another account must be debited. Under the accrual method of accounting, revenues are reported on the income statement in the period in which they are earned. Under the accrual method of accounting, expenses are reported on the income statement in the period in which they are used up or match up with revenues.aia To learn more about debits and credits, the accounting equation, chart of accounts, income statement, balance sheet, and more, visit the free website AccountingCoach.com. There you will find free explanations, quizzes, puzzles, Q&A, dictionary, and more,ice reRe ely Questions 1-6 of 15 QUIZ FOR DEBITS AND CREDITS 1. The word used to indicate the left side of an accountis) 2. The word used to indicate the right side of an accountis[| 3. The accounting equation is: = + Il 4. Under Lentry accounting, two or more accounts are involved in every business transaction. 5. Reporting revenues when they are earned instead of when the cash is received is known as the method of accounting. 6. When a company pays cash for an expense, the account Cash will need a (select one) (Cldebit 1 (credit ) entry, and an expense account will need a (Cldebit 1 C1 credit ) entry.eoicereRe elma Questions 7-9 of 15 QUIZ FOR DEBITS AND CREDITS 7. When a company pays one of its accounts payable, the account Cash will need a (Tdebit 1 1 credit ) entry, and the account Accounts Payable will need a (Cldebit / (1 credit ) entry. 8. When a company collects one of its accounts receivable, the account Cash will need a (L]debit / (1) credit ) entry, and the account Accounts Receivable will need a (C)debit 1 (1 credit ) entry. 9. Acompany incurs an expense on May 15, but doesn't have to make payment until June 15. On May 15, t the company should (a. debit a liability account (1b. debit an asset account Oe. credi ita liability account (Vd. credit an asset accountfete eke sical Questions 10-15 of 15 QUIZ FOR DEBITS AND CREDITS 10. Revenue accounts will almost always have ([_| debit / |_| credit ) balances. 41. Expense accounts will almost always have ({_] debit / [_] credit ) balances. 12. Asole proprietor’s capital account will be part of [ which is one of the components of the accounting equation and the balance sheet. 13. A(LJdebit / [1 credit) entry will reduce the balance of a liability account. 14. Loans Payable or Notes Payable could be a current or noncurrent account. 15. Revenues and aps minus expenses and losses equals a sole proprietor’s netPier Re ay Answers 1-6 of 15 ANSWERS TO DEBITS AND CREDITS QUIZ 1. The word used to indicate the left side of an account is debit 2. The word used to indicate the right side of an account is credit 3. The accounting equation is: Assets =___ Liabilities + Owner's Equity 4. Under____double -entry accounting, two or more accounts are involved in every business transaction 5. Reporting revenues when they are eared instead of when the cash is received is known as the accrual method of accounting. 6. When a company pays cash for an expense, the account Cash will need a (select one) (Ll debit 1 X credit) entry, and an expense account will need a (Rdebit / [credit ) entry.Lee UleRet-elicay Answers7-9 of 15 ANSWERS TO DEBITS AND CREDITS QUIZ 7. When a company pays one of its accounts payable, the account Cash will need a (Lldebit 1 XJ credit) entry, and the account Accounts Payable will need a (X debit / [] credit ) entry. 8. When a company collects one of its accounts receivable, the account Cash will need a (XJ debit / [_| credit ) entry, and the account Accounts Receivable will need a (Lldebit 1 XJ credit) entry. 9. Acompany incurs an expense on May 15, but doesn't have to make payment until June 15. On May 15, the company should (Ja. debit a liability account (1b. debit an asset account Xc. credit a liability account (id. credit an asset accountPie Tre Rey slay Answers 10-15 of 15 ANSWERS TO DEBITS AND CREDITS QUIZ 40. Revenue accounts will almost always have ([_] debit / Xj credit) balances. 11. Expense accounts will almost always have (IX debit /(_] credit ) balances. 42. Asole proprietor's capital account will be part of. owner's equity, which is one of the components of the accounting equation and the balance sheet. 13. A(X debit /(_] credit ) entry will reduce the balance of a liability account. 14. Loans Payable or Notes Payable could be a current or noncurrent ___ liability account. 15. Revenues and gains minus expenses and losses equals a sole proprietor's net come