As a small business owner, you may be struggling with the concept of what is debit (DR) and credit (CR). But, learning the basics of debit and credit is essential for keeping accurate records for your small business.
To have a better understanding of debits and credits, continue reading for more information and examples of each.
Understanding debits and credits in accounting
Business transactions take place regularly. You must record business transactions in your small business accounting books. You will record these transactions in two accounts: a debit and credit account.
Debit vs. credit
Debits and credits are equal but opposite entries in your books. If a debit increases an account, you will decrease the opposite account with a credit.
A debit is an entry made on the left side of an account. It either increases an asset or expense account or decreases equity, liability, or revenue accounts. For example, you would debit the purchase of a new computer by entering the asset gained on the left side of your asset account.
A credit is an entry made on the right side of an account. It either increases equity, liability, or revenue accounts or decreases an asset or expense account. Record the corresponding credit for the purchase of a new computer by crediting your expense account.
Debit and credit accounts
Record credits and debits for each transaction that occurs. You record two or more entries for every transaction. This is considered double-entry bookkeeping.
You will separate your transactions into accounts while doing your bookkeeping. Five common accounts include:
- Assets: Resources owned by a business which have economic value you can convert into cash (e.g., land, equipment, cash, vehicles)
- Expenses: Costs that occur during business operations (e.g., wages, supplies)
- Liabilities: Amounts owed to another person or business (e.g., accounts payable)
- Equity: Your assets minus your liabilities
- Revenue: Cash earned from sales
Debits and credits affect each account differently. Check out our debits and credits chart below to see how they are affected:
Debits and credits T chart
This is a basic template of how you would record debits and credits as a journal entry:
Examples of debits and credits
To get a better understanding of the basics of recordkeeping, let’s look at a few debits and credits examples.
Say your company sells a product to a customer for $500 in cash. This would result in $500 of revenue and cash of $500. You would record this as an increase of cash (asset account) with a debit, and increase the revenue account with a credit.
Looking at another example, let’s say you decide to purchase new equipment for your company for $15,000. The equipment is a fixed asset, so you would add the cost of the equipment as a debit of $15,000 to your fixed asset account. Purchasing the equipment also means you will increase your liabilities. You will increase your accounts payable account by crediting it $15,000.
You would record the new equipment purchase of $15,000 in your accounts like this:
Here are some additional examples of accounting basics for debits and credits:
- Repay a business loan: Debit loans payable account and credit cash account.
- Sell to a customer on credit: Debit accounts receivable and credit the revenue account.
- Purchase inventory from your vendor and pay cash: Debit inventory account and credit the cash account.
Summary of debits and credits
You must have a grasp of how debits and credits work to keep your books error-free. Accurate bookkeeping can give you a better understanding of your business’s financial health. Debits and credits are used to prepare critical financial statements and other documents that you may need to share with your bank, accountant, the IRS, or an auditor.
Check out a summary of the key points discussed regarding debits and credits.
- Debits increase as credits decrease.
- Record on the left side of an account.
- Debits increase asset and expense accounts.
- Debits decrease liability, equity, and revenue accounts.
- Credits increase as debits decrease.
- Record on the right side of an account.
- Credits increase liability, equity, and revenue accounts.
- Credits decrease asset and expense accounts.
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This article was updated from its original publication date of 12/3/2015.
This is not intended as legal advice; for more information, please click here.