The terms “debit” and “credit” are enough to induce fear in even the most intrepid non-accountant. But even though you may never become an accountant, you will need to understand these concepts in order to have a solid grasp of accounting and business. In this chapter you’ll learn what these terms mean and how they are used in the world of accounting.
What Is a Debit?:
The word debit simply refers to the left side of the amount columns and the word credit identifies the right side of the amount columns. Nothing more, nothing less. Debit does not mean something unfavorable and credit does not mean something favorable, as some non-accountants often believe.
The General Journal
Some time after a business transaction occurs it is recorded in a book called the general journal. While there are many different kinds of journals, it is most important to focus on the general journal. A general journal is often referred to as the book of original entry because this journal is the book in which a transaction is first recorded.
If a company were to buy land for cash, the pages of a general journal will look like the one shown below in Figure 6.1 (the entries in this figure do not come from Solana Beach Bicycle Company but are simply examples):
A = L + OE
The standard accounting rule is that Assets, or the left side of the equation, are increased with debits, and decreased with credits, while the right side of the equation, the Liabilities and the Owner’s Equity items are just the opposite; that is, they are increased with credits, and decreased with debits. When you increase or decrease the debits, by the same amount as you increase or decrease the credits on each transaction, you make sure that the debits always equal the credits, a key goal of bookkeeping.
If the debits do not equal the credits at the end of the period, (month, quarter, or year), it indicates that a mistake was made somewhere along the line and one of the transactions was entered improperly. By using this system, the Accounting Equation always stays in balance after each transaction is recorded since you are increasing or decreasing both sides of the equation by equal amounts. There is a standard way of dealing with debits and credits assigned to Assets, Liabilities, Owner’s Equity, Revenues, and Expenses. Figure 6.2 below summarizes this concept:
Now let’s record in the general journal some of the transactions of the previous chapters. It is important to remember that every single transaction in the journal must be recorded as both a debit and a credit. First, Sam invested $60,000 in her bicycle company. This transaction would be recorded as shown in Figure 6.3:
You already know that whenever the owner of a business invests cash into his or her business, cash is increased and so is the Owner’s Investment (part of Owner’s Equity). If cash (an Asset) increases, this is shown as a debit in the journal; the increase in Owner’s Equity is listed as a credit. (See Figure 6.2 above.)
In the next transaction, the company buys a building, land, and a truck for $43,000. Since the bicycle shop does not have sufficient cash to pay for all of these Assets, the owner needs to borrow $20,000 and pays the remainder in cash ($23,000). This transaction would be recorded in the general journal as shown in Figure 6.4:
Notice in the above journal entry, DEBITS were used to increase the Assets (land, building, and truck), while CREDITS were used to decrease Asset (cash), but to increase the Liability Mortgage Payable. Thus, depending upon which side of the accounting equation the account appears, this will determine if it is recorded as a debit or a credit (see Figure 6.2).
Now we’ll move on to the transactions from chapter 4, which were recorded on the Income Statement.
On January 5, the bicycle company sold two bicycles for a total of $500. As you remember, this one transaction caused two changes to the Income Statement. First, it increased the Revenue account called “Sales” by $500, and second, it increased an Expense account called “Cost of Goods Sold” by the cost of these two bicycles or $200. Remember also that at the same time that this transaction is causing a change to the Income Statement, it is also causing the Balance Sheet to change in several ways. These bicycles were sold for cash; thus, the Asset cash would increase by $500. The Asset Inventory would decrease by their cost of $200 (since the bicycles (Inventory) do not belong to the company any longer). The $300 difference between the sale price and the cost ($500 – $200) would be an increase to Retained Earnings, which is part of Owner’s Equity.
Notice in the transaction below in Figure 6.5, there is no entry for Retained Earnings or Owner’s Equity. The “profit” from this transaction of $300, simply appears in the Balance Sheet (as Retained Earnings) when the Revenue ($500) and the Expense ($200) are recorded.
These two transactions would be recorded in the general journal as seen below in Figure 6.5:
Referring back to the Accounting Equation, A = L + OE, the sales transaction has increased the left side (the Asset Cash) by $500, and increased the right side, Owner’s Equity by the same amount. The second part of this transaction that reduces the Inventory also keeps the accounting equation in balance, the Expense of the bikes (the debit), and the decrease in Inventory (the credit). In both of these transactions, the debits to record these transactions are equal to the credits.
Looking at another transaction in chapter 4, Operating Expenses, you can see the impact on the General Journal. On January 7, Solana Beach Bicycle Company pays Sam her first week’s pay of $100. This transaction would be recorded in the General Journal as shown in Figure 6.6:
This transaction has decreased the left side of the accounting equation, Assets or Cash by $100, and has also decreased the right side Owner’s Equity with an Expense by the same amount. Once again, the debits equal the credits.
Finally look at one more transaction from chapter 4, where Solana Beach Bicycle Company repairs some bicycles for $375. The parts for these repairs cost the company $105, paid for in cash. This transaction is recorded in the General Journal as follows in Figure 6.7:
Once again, notice that in the first part of this transaction, the left side of the accounting equation is increased by $375, and the right side, Owner’s Equity (via a Revenue item), is increased by the same amount.
In the second part of the transaction, the right side is decreased with a credit to an Asset (cash) by $105, and the left side is decreased with a debit to an Owner’s Equity account (Repairs Expense). Thus the equation (A = L + OE) stays in balance, and the debits equal the credits.