We saw the effect of business transactions on the accounting equation In the previous post. However, we don’t analyze transactions that way in day to day bookkeeping.
Instead, we use ledger accounts to record them.
Ledger accounts refer to recording of increases and decreases in specific asset, liability, equity, revenue, or expense items. Examples of ledger accounts are cash, accounts receivables, accounts payable, and salaries.
In its basic form, a ledger account consists of its name, left side (debit), and right side (credit).
Ledger account name
Since the shape looks like a T in the alphabet, the diagram is called T-account.
Debit and Credit
The terms debit and credit are frequently used in bookkeeping, however, they don’t mean decrease or increase as used in everyday conversation. Instead, debit simply means the left side of a ledger account, and credit means the right side.
When recording a transaction, whether to enter its amount on the debit side or credit side is determined by the account’s category. If the transaction is on an asset account like cash, an increase is recorded on the debit side, and an decrease on the credit side.
Let’s see an actual example.
Let’s say we have the following transactions in the cash account. The plus sign means an increase in cash, and the minus sign means a decrease.
In the T-account form, they will be expressed as follows.
We don’t use the plus or minus sign. Instead, we express increase or decrease by entering absolute numbers in either the debit or the credit side. In addition, we calculate the net account balance by summing each side and netting them. If the debit side exceeds the credit side, we enter the balance on the debit side, and vice versa. We can see how the t-account form makes it convenient for us to calculate the subtotals of each side because increases and decreases are grouped together.
Next, let’s examine a liability account. Suppose we have the following transactions for the accounts payable account.
The transactions above are expressed in the T-account as follows.
In an asset account, a debit number means an increase, and a credit number means a decrease. In a liability account, it's the opposite, and a debit number means a decrease, and a credit number means an increase.
We have examined 2 patterns. On the first one, debit means an increase, and credit means a decrease. One the second one, debit means a decrease, and credit means an increase.
Every transaction in accounting falls into one of these two patterns. The remaining equity, revenue, and expense account categories are no exceptions.
Account categories that increase with debit and decrease with credit.
Account categories that decrease with debit and increase with credit.
When recording transactions, it is important to be able to instantly identify whether an increase or decrease is debit or credit for each account category.
In order to do so, it helps to understand the logic behind why certain account categories are associated with one pattern against another, rather than simply trying to memorize the patterns.
How to remember whether a specific account uses a debit or credit for increase/decrease.
I personally recommend the method befow, which uses the accounting equation.
Assets = Liabilities + Equity
That is, if the position of an item of the equation matches the side on the T-account, it is an increase. If it doesn’t match, it’s a decrease.
For example, an asset account is positioned on the left side of the equation. Therefore, an entry on the same left side (debit) of the T-account means an increase. Conversely, if an entry is on the opposite side (right or credit) of the T-account, it is a decrease.
On the other hand, a liability account is positioned on the right side of the equation. Therefore, an increase in the account should be entered on the same side (right side or credit), and a decrease should be entered on the opposite side (left side or debit).
As for revenue and expenses accounts, we can remember the same way by expanding the equation.
Assets = Liabilities + Equity + Revenues - Expenses
We tweak the equation a bit in order to make Expenses positive.
Assets + Expenses = Liabilities + Equity + Revenues
Now that every component has a plus sign, we can apply the same method.
A revenue account is positioned on the right side of the equation. Therefore, similar to a liability account, an increase in the account should be entered on the same side (right side or credit), and a decrease should be entered on the opposite side (left side or debit).
On the other hand, an expense account is positioned on the left side of the equation. Therefore, an entry on the same left side (debit) of the T-account means an increase. Conversely, if an entry is on the opposite side (right or credit) of the T-account, it is a decrease.
Another way to remember debit/credit of revenue and expense accounts is to consider their relationship to Equity. In the accounting equation, an increase in revenue leads to an increase in Equity. Therefore, a revenue account uses the same sides of the T-account as an equity account to record an increase or decrease. On the other hand, an increase in an expense account leads to a decrease in Equity. Therefore, an expense account uses the opposite sides of the T-account as an equity account to record an increase or decrease.
There is no right or wrong way to remember the debit and credit sides for each account. As long as it is correct, you should use any method that you feel comfortable with.