Debits and Credits

Part 1

Introduction to Debits and Credits, What's an "Account"?, Double-Entry Accounting, Debits & Credits

Part

2

T–accounts, Journal Entries, When Cash Is Debited and Credited

Part

3

Normal Balances, Revenues & Gains are Usually Credited, Expenses & Losses are Usually Debited, Permanent & Temporary Accounts

Part

4

Bank's Debits & Credits, Bank's Balance Sheet, Recap

I

If the words "debits" and "credits" sound like a foreign language to you, you are more perceptive than you realize—"debits" and "credits" are words that have been traced

back five hundred years to a document describing today's double-entry accounting system.

Under the double-entry system every business transaction is recorded in at least two accounts. One

account will receive a "debit" entry, meaning the amount will be entered on the left side of that account. Another

account will receive a "credit" entry, meaning the amount will be entered on the right side of that account. The initial

challenge with double-entry is to know which account should be debited and which account should be credited.

What Is An Account?To keep a company's financial data organized,

accountants developed a system that sorts transactions into records called accounts. When a

company's accounting system is set up, the accounts most likely to be affected by the

company's transactions are identified and listed out. This list is referred to as the company's chart of accounts. Depending on the size of a company and the complexity of its business operations, the

chart of accounts may list as few as thirty accounts or as many as thousands. A company has the

flexibility of tailoring its chart of accounts to best meet its needs.

A chart of accounts is a listing of the names of the accounts that a company has identified and made available for recording transactions in its general ledger. A company has the flexibility to tailor its chart of accounts to best suit its needs, including adding accounts as needed.Within the chart of accounts you will find that the accounts are typically listed in the following order:

Balance sheet accounts

Assets Liabilities Owner's (Stockholders')

Equity

Income statement accounts Operating

Revenues Operating

Expenses Non-operating

Revenues and Gains

Non-operating Expenses and Losses

Within the categories of operating revenues and operating expenses, accounts might be further organized by business

function (such as producing, selling, administrative, financing) and/or by company divisions, product lines, etc. A company's organization chart can serve as the outline for its accounting chart of accounts. For example, if a company

divides its business into ten departments (production, marketing, human resources, etc.), each department will

likely be accountable for its own expenses (salaries, supplies, phone, etc.). Each department will have its own phone expense account, its own salaries expense, etc.

A chart of accounts will likely be as large and as complex as the company itself. An international corporation with several divisions may need thousands of accounts, whereas a small

local retailer may need as few as one hundred accounts.

Each account in the chart of accounts is typically assigned a name and a unique number by which it

can be identified. (Software for some small businesses may not require account numbers.) Account numbers are often five or more digits in

length with each digit representing a division of the company, the department, the type of account, etc.

As you will see, the first digit might signify if the account is an asset, liability, etc. For example, if

the first digit is a "1" it is an asset. If the first digit is a "5" it is an operating expense.

A gap between account numbers allows for adding accounts in the future. The following is a partial

listing of a sample chart of accounts.

Current Assets (account numbers 10000 - 16999)10100   Cash - Regular Checking10200   Cash - Payroll Checking

10600   Petty Cash Fund12100   Accounts Receivable

12500   Allowance for Doubtful Accounts13100   Inventory14100   Supplies

15300   Prepaid InsuranceProperty, Plant, and Equipment (account numbers 17000 - 18999)

17000   Land17100   Buildings

17300   Equipment17800   Vehicles

18100   Accumulated Depreciation - Buildings18300   Accumulated Depreciation - Equipment18800   Accumulated Depreciation - Vehicles

Current Liabilities (account numbers 20000 - 24999)20100   Notes Payable - Credit Line #120200   Notes Payable - Credit Line #2

21000   Accounts Payable22100   Wages Payable23100   Interest Payable

24500   Unearned RevenuesLong-term Liabilities (account numbers 25000 - 26999)

25100   Mortgage Loan Payable25600   Bonds Payable

25650   Discount on Bonds PayableStockholders' Equity (account numbers 27000 - 29999)

27100 Common Stock, No Par27500 Retained Earnings

29500 Treasury StockOperating Revenues (account numbers 30000 - 39999)

31010   Sales - Division #1, Product Line 01031022   Sales - Division #1, Product Line 02232015   Sales - Division #2, Product Line 01533110   Sales - Division #3, Product Line 110

Cost of Goods Sold (account numbers 40000 - 49999)41010   COGS - Division #1, Product Line 01041022   COGS - Division #1, Product Line 02242015   COGS - Division #2, Product Line 01543110   COGS - Division #3, Product Line 110

Marketing Expenses (account numbers 50000 - 50999)50100   Marketing Dept. Salaries

50150   Marketing Dept. Payroll Taxes50200   Marketing Dept. Supplies

50600   Marketing Dept. TelephonePayroll Dept. Expenses (account numbers 59000 - 59999)

59100   Payroll Dept. Salaries59150   Payroll Dept. Payroll Taxes

59200   Payroll Dept. Supplies59600   Payroll Dept. Telephone

Other (account numbers 90000 - 99999)91800   Gain on Sale of Assets96100   Loss on Sale of Assets

Within the chart of accounts the balance sheet accounts are listed first, followed by the income statement accounts. In other words, the accounts are organized in the chart of

accounts as follows:Assets

LiabilitiesOwner's (Stockholders') Equity

Revenues or IncomeExpenses

GainsLosses

Because every business transaction affects at least two accounts, our accounting system is known as a double-entry system. (You can refer to the company's chart of accounts to

select the proper accounts. Accounts may be added to the chart of accounts when an appropriate account cannot be found.)

For example, when a company borrows $1,000 from a bank, the transaction will affect the company's Cash account and the

company's Notes Payable account. When the company repays the bank loan, the Cash account and the Notes Payable account

are also involved.If a company buys supplies for cash, its Supplies account and its Cash account will be affected. If the company buys supplies on

credit, the accounts involved are Supplies and Accounts Payable.

If a company pays the rent for the current month, Rent Expense and Cash are the two accounts involved. If a

company provides a service and gives the client 30 days in which to pay, the company's Service Revenues account and

Accounts Receivable are affected.Although the system is referred to as double-entry, a transaction may involve more than two accounts. An

example of a transaction that involves three accounts is a company's loan payment to its bank of $300. This

transaction will involve the following accounts: Cash, Notes Payable, and Interest Expense.

(If you use accounting software you may not actually see that two or more accounts are being affected due to the

user-friendly nature of the software. For example, let's say that you write a company check by means of your

accounting software. Your software automatically reduces your Cash account and prompts you only for the other

accounts affected.)

Accountants and bookkeepers often use T-accounts as a visual aid for seeing the effect of the debit and credit on the two (or more) accounts. (Learn more about accountants and bookkeepers in our Accounting Careers area.) We will begin with two T-accounts: Cash and Notes Payable.

                       Cash (asset account)

DebitIncreases an assetReceived $

CreditDecreases an assetPaid $

 Notes Payable (liability account)

DebitDecreases a liabilityRepaid loan

CreditIncreases a liabilityBorrowed more

Let's demonstrate the use of these T-accounts with two transactions:

On June 1, 2009 a company borrows $5,000 from its bank. This causes the company's asset Cash

to increase by $5,000 and its liability Notes Payable to also increase by $5,000. To increase the asset Cash the account needs to be debited. To increase the company's liability Notes Payable this account needs to be credited. After entering the debits and credits the T-accounts look like

this:

                       Cash (asset account)

DebitIncreases an assetReceived $

CreditDecreases an assetPaid $

June 1, 2009

ENTRY

5,000

                         Notes Payable (liability account)

DebitDecreases a liabilityRepaid loan

CreditIncreases a liabilityBorrowed more

5,000

ENTRY June 1, 2009

Whenever cash is received, the Cash account is debited (and another account is credited).Whenever cash is paid out, the Cash account is credited (and another account is debited).Normal BalancesWhen looking at a T-account for each of the account classifications in the general ledger, here is the debit or credit balance you would normally find in the account:

Account ClassificationNormal

Balance

Assets Debit

Contra asset Credit

Liability Credit

Contra liability Debit

Owner's Equity Credit

Stockholders' Equity Credit

Owner's Drawing orDividends Account

Debit

Revenues (or Income) Credit

Expenses Debit

Gains Credit

Losses Debit