Last editedSep 20222 min read
Good accounting practices are essential to running a business, whether small or large. For this reason, it’s important that all business owners have at least a basic grasp of accounting and the fundamental concepts that underpin it. Two of the most crucial terms in this respect are debits and credits in accounting.
But what is the difference between debit and credit in accounting? Put simply, debits are a record of all the money that flows into an account, whereas credits represent all the money that leaves the account. This is the basic principle of double entry accounting, which states that for every entry in one account, an equal entry must be made in another. Keep reading to better understand debit and credit in accounting.
What is debit and credit in accounting?
Debits and credits are basically ways of recording business transactions, which are events that have an impact on thefinancial statements of a business. When accounting these types of transactions, a record is made in two different columns: the debit column and the credit column.
A debit refers to accounting entries that increase the balance of an expense or asset account, or one that decreases the balance of a liability or equity account. Conversely, a credit is one that increases the balance of liability and equity accounts, and decreases that of assets and expense accounts.
Debits and credits with the double entry accounting method
One of the main reasons to understand debit and credit in accounting is to be able to use the double entry accounting method. In this system, all of your business is organized into distinct accounts that represent different areas of your business.
For example, you might have an account that details the value of all the equipment your business owns, and another could show all the cash you have in your business bank account.
When you have separated your business into different accounts like this, it’s useful to have simple terminology that can describe the movement of funds into and out of these accounts. So what is the difference between debit and credit in accounting? A debit shows money going into one of these accounts, whereas a credit shows money leaving the account.
Rules for debit and credit in accounting
It’s much easier to understand the basic rules for debit and credit in accounting through an example. Let’s say your business needs to purchase some new equipment for manufacturing, and this will cost you $1000. How will this impact your different business accounts?
First of all, $1000 will be taken from your cash account. We call this a credit, since money is leaving the account; you can also say that you are crediting the cash account. Following this, your equipment account will be debited the value of the equipment, since this represents an increase in assets.
Debits and credits and liability accounts
You now know the answer to the question: what is debit and credit in accounting?
However, when it comes to liability accounts, the effects can be a little harder to understand. Liabilities, whether they are long term or shorter, represent everything that your business owes to other businesses or individuals.
So, to continue the previous equipment example, let’s say you had to take out a $1000 bank loan to cover the costs of the new manufacturing equipment. Taking out this loan would debit your business cash account by $1000.
However, that’s not the only account that is impacted. You will also need to increase the value of the bank loan account by $1000. But since this is a liabilities account, we refer to this as a credit. This can be a bit confusing, since the value of the account is going up, but we refer to it as a credit. That’s because the value of the account actually represents debt.
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