Unit 8: Analyzing Business

Transactions
Lesson 8.3
Rules of Debit and Credit
Contents
Introduction 1

Learning Objectives 2

Quick Look 3

Learn the Basics 4

Rules for Balance Sheet Accounts 5
Asset Accounts 5
Liability Accounts 6
Equity Accounts 6
Rules for Income Statement Accounts 8
Income Accounts 8
Expense Accounts 8
Normal Balances of an Account 9

Keep in Mind 10

Try This 11

Practice Your Skills 12

Challenge Yourself 13

Photo Credit 14

Bibliography 14
Unit 8: Analyzing Business
Transactions
Lesson 8.3

Rules of Debit and Credit

Introduction

Rules guide an individual on what is or is not allowed. Rules are present in every aspect
of our lives. It can be applied in school, work, and even at home. Without rules, things
might not be aligned with the standards. That is why a business or an individual needs to set
rules to be accurate or reliable.

There are many rules or guidelines to be familiar with in accounting. Some concepts or
principles serve as guidelines for correctly validating and analyzing a transaction. In this
lesson, you will learn a new set of rules that can be used to record transactions in the
accounting books.

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Unit 8: Analyzing Business
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Learning Objectives DepEd Competencies

At the end of this lesson, you should be able to Analyze common business transactions using the rules of debit an
(ABM_FABM11-IIIg-j-27).
do the following: Solve simple problems and exercises in the analyses of business t
(ABM_FABM11-IIIg-j-28).
● Define the rules of debit and credit in
accounting in balance sheet accounts
and income statement accounts.

● Demonstrate the effect of transactions

on major accounts.
● Analyze business transactions using the
rules of debit and credit.

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Unit 8: Analyzing Business
Transactions
Quick Look

Carlo’s Dream
Carlo is fulfilling his dream of becoming an entrepreneur at a young age. To be familiar with
the strategies in business management, he enrolled in a business course. He also took
accounting and finance classes because he also wanted to understand the financial aspect
of his business better.

Carlo learned about the different perspectives in accounting, such as the various concepts
and principles, accounting equations, major accounts, and accounting books. However, he is
most interested in the rules of debit and credit and their e ffects on the di fferent
accounts. At some point, he pondered how these rules might a ffect his future business or
whether or not this has a significant impact on his dreams of becoming an entrepreneur.

Questions to Ponder
1. What are the challenges of familiarizing oneself with different accounting
aspects such as the rules of debit and credit?

2. How important is it for a rookie entrepreneur to have knowledge in accounting,

especially in the rules of debit and credit?

3. What is the impact of not having enough knowledge in accounting before starting up

a business?

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Unit 8: Analyzing Business
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Learn the Basics

In the previous unit, the types of major accounts were introduced. These major
accounts are assets, liabilities, owner’s equity, income, and expenses. Every valid
business transaction that is recognized by the business increases or decreases these
major accounts. The previous unit also discussed accounting books such as journals and
ledger. The journal is used to record business transactions and shows the amount debited
and credited, while the ledger summarizes the ending balances of every account used by
the business.

In recording a business transaction, the double-entry system is used. This means that a
business transaction has at least two effects, and therefore will affect at least two accounts.

An account tracks the financial activities of an asset, liability, owner’s equity, income, or
expense. It records the increases and decreases as the business's economic events occur
throughout the accounting period. Each individual account is stored in a general ledger or in
a T-Account.

A T-account is a graphical representation of a ledger and it defines the appearance of

the bookkeeping entries. First, a large letter T is drawn. Then, the account title is placed on
the top horizontal line. Below, debit amounts are recorded on the left side, while credit
amounts are listed on the right side; separated by the vertical line of the letter T.

Account Title

Debit Credit

Moreover, the double-entry system requires that a transaction must have a debit and credit
entry and that their amounts must always be equal. This way, both sides of the accounting
equation remain balanced.

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Unit 8: Analyzing Business
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An entry made on the left side of an account is a debit; while an entry made on the right
side of an account is a credit. Every account recorded in the debit or credit side signifies an
increase or decrease in the balances of the accounts.

Essential Question
Why must a business follow the rules of debit and credit when recording business transactions?

Check Your Progress

Explain the double-entry system.

Rules for Balance Sheet Accounts

A Balance Sheet shows the financial position of a business in a specific time period,
presenting the assets, liabilities, and owner’s equity of a business. The following section will
discuss the rules of debits and credits for balance sheet accounts.

Asset Accounts
Assets are objects or entities that the company owns and have an economic value. An
increase in asset is recorded on the debit side and a decrease in asset is recorded on the
credit side.

On the other hand, the rules of debit and credit for contra-asset accounts are based on their
relationship with assets. Contra-asset accounts are accounts that reduce the value of their
related asset accounts. Hence, an increase in a contra-asset is recorded as a credit.

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Unit 8: Analyzing Business
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Liability Accounts
Liabilities are debts or obligations of an entity to other individuals or companies. An
increase in liability is recorded on the credit side, while a decrease in liability is recorded on
the debit side.

Equity Accounts
Equity is the owner's rights to the business's assets. An increase in equity is recorded on the
credit side of the account, while a decrease in equity is recorded on the debit side of the
account.

On the other hand, the rules of debit and credit for the drawing account are based on its
relationship with the owner's equity. A withdrawal made by the owner decreases the owner's
equity. Hence, an increase in drawing is recorded on the account's debit side.

Table 1. Rules of Debit and Credit of Balance Sheet accounts

DEBIT CREDIT

⬆ Asset ⬇ Asset

⬇ Contra-Asset ⬆ Contra-Asset

⬇ Liability ⬆ Liability

⬇ Equity - Capital ⬆ Equity - Capital

⬆ Equity - Drawing ⬇ Equity - Drawing

Closer Look
Example 1: The owner invested cash in an internet business. Analysis: The transaction increased

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Unit 8: Analyzing Business
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Example 2: The business purchased equipment in cash.
Analysis: The transaction increased the asset of the business (equipment)
and decreased another asset of the business (cash). Following the rules
of debit and credit, the increase in asset will be recorded as a debit
while the decrease in another asset will be recorded as a credit.
Therefore, the debit entry is Equipment; while the credit entry is Cash.

Example 3: The business purchased a computer on credit.

Analysis: The transaction increased the asset of the business (equipment)
and increased the liability of the business (accounts payable). Following
the rules of debit and credit, the increase in asset will be recorded as a
debit while the increase in liability will be recorded as a credit. Therefore,
the debit entry is Equipment; while the credit entry is Accounts Payable.

Example 4: Paid supplier for the computer purchased.

Analysis: The transaction decreased the liability of the business (accounts
payable) and decreased the asset of the business (cash). Following the
rules of debit and credit, the decrease in liability will be recorded as a
debit while the decrease in asset will be recorded as a credit.
Therefore, the debit entry is Accounts Payable; while the credit entry is
Cash.

Example 5: The owner withdrew cash in the business for

investments.
Analysis: The transaction decreased the equity of the business (drawing)
and decreased the asset of the business (cash). Following the rules of
debit and credit, the decrease in equity will be recorded as a debit
while the decrease in asset will be recorded as a credit. Therefore, the
debit entry is Drawing; while the credit entry is Cash.

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Unit 8: Analyzing Business
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Rules for Income Statement Accounts
An income statement shows the company’s financial performance for a specified time
period. It also presents the company’s income and expenses. The following are the rules of
debit and credit for income statement accounts.

Income Accounts
The income account comprises the actual earnings of a business over a period of time, either
in cash or on account. Income is also known as revenue. An income increases the owner's
equity. Hence, an increase in income is recorded on the credit side while a decrease in
income is recorded on the debit side.

Expense Accounts
Expenses are costs incurred from operating activities during a specified accounting period.
An expense decreases the owner's equity. Hence, an increase in expense is recorded on the
debit side while a decrease in expense is recorded on the credit side.

Table 2. Rules of Debit and Credit of Income Statement accounts

DEBIT CREDIT

⬇ Income ⬆ Income

⬆ Expense ⬇ Expense

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Closer Look

Example 1: The business rendered services to a client for cash.

Analysis: The transaction increased the asset of the business (cash) and
increased the revenue of the business (service revenue). Following the
rules of debit and credit, the increase in asset will be recorded as a debit
while the increase in revenue or income will be recorded as a credit.
Therefore, the debit entry is Cash; while the credit entry is Service
Revenue.

Example 2: The business paid the electric bill for the month of
December.
Analysis: The transaction increased the expense of the business (utilities)
and decreased the asset of the business (cash). Following the rules of
debit and credit, the increase in expense will be recorded as a debit while
the decrease in asset will be recorded as a credit. Therefore, the debit
entry is Utilities Expense; while the credit entry is Cash.

Example 3: The business performed services to a client on account.

Analysis: The transaction increased the asset of the business (accounts
receivable) and increased the revenue of the business (service revenue).
Following the rules of debit and credit, the increase in asset will be
recorded as a debit while the increase in revenue or income will be
recorded as a credit. Therefore, the debit entry is Accounts Receivable;
while the credit entry is Service Revenue.

Normal Balances of an Account

In the previous lesson, the normal balance of an account had been introduced. To recall, the
normal balance of an account is the side of an account, either a debit or a credit, where
increases are recorded. The following accounts have normal debit balances: asset, drawing,
and expenses, while the following accounts have normal credit balances: liabilities, owner’s
equity, and income.

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Unit 8: Analyzing Business
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Check Your Progress

Explain the concept of normal balance of an account.

Keep in Mind

● The rules of debit and credit guide accountants in analyzing and recording
transactions.
● In recording transactions, the double-entry system is used. It means that a business
transaction has at least two effects, and therefore will affect at least two accounts.
● A debit is an entry made on the left side of an account, while credit is an entry made
on the right side.
● The rules of debit and credit are summarized in the following table:

Account In case In case of Normal Balance

of decrease
increase
Asset Debit Credit Debit

Contra Asset Credit Debit Credit

Liability Credit Debit Credit

Capital Credit Debit Credit

Drawing Debit Credit Debit

Income Credit Debit Credit

Expenses Debit Credit Debit

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Unit 8: Analyzing Business
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Try This

A. Identification. Determine whether the increases and decreases in the given

accounts will be debited or credited, and give the Normal Balance for each
account. See the example below.

Account Type In case In case of Normal

of decrease Balance
increase
Example: Cash Debit Credit Debit

1. Accounts Payable

2. Accounts Receivable

3. Accumulated Depreciation

4. Capital

5. Drawing

6. Equipment

7. Rent Expense

8. Service Income

9. Supplies

10. Utilities Expense

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Unit 8: Analyzing Business
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Photo Credit

Coins by stevepb (Pixabay) is free to use under the Pixabay License via Pixabay.

Bibliography

Boyd, Ken, et al. Accounting for Dummies: All in One. NJ: John Wiley & Sons, Inc, 2014.

Corporate Finance Institute. “T Accounts Guide.” Accessed on February 16, 2022.

https://corporatefinanceinstitute.com/resources/knowledge/accounting/t-accounts/
#:~:text=The%20left%20side%20of%20the,the%20right%20side%2C%20by%20conve
ntion.

Gilbertson, Claudia and Mark Lehman. Century 21 Accounting. Ohio: South-Western

Cengage Learning, 2008.

8.3. Rules of Debit and 12