Understanding Debits and Credits with Examples

The terms debit and credit are derived from Latin terminology. Debit is derived from the Latin word ‘Debere’ which means to ‘to owe. Credit is derived from the Latin word ‘Credere’ which is translated as ‘to entrust’

In a standard ledger account, a debit entry is posted on the left side of the T account and usually labelled as ‘Dr’. A credit entry is posted on the right side of a ledger account and is abbreviated as ‘Cr’.

There is a lot of confusion as to when an account should be credit or debited. To understand whether to debit or credit and account we first need to understand the different types of accounts and then learn the treatment in case of an increase or a decrease in that account.

Any financial transaction performed in a business organization can be classified under one of the following accounts:

  • Asset Account
  • Liability Account
  • Equity Account
  • Revenue Account
  • Expense Account

It is worth noting here that the first 3 accounts listed above feature on the balance sheet of an organization and have running balances (balance carried forward to next accounting year). The last two accounts are used in preparation of profit and loss account of an organization and the balances are not carried forward to the next accounting period.

The following table clearly illustrates if an account should be debited or credited with an increase or decrease in its balance.

 

Account Increase in Value Decrease in Value
Assets Debit Credit
Liability Credit Debit
Equity Credit Debit
Revenue Credit Debit
Expense Debit Credit

 

The following examples of financial transactions record the increase and decrease in each account along with a brief commentary on each transaction for clear understanding:

  • Purchase of office furniture for $100 cash

 

Doubt Entry:                                                       Dr.                          Cr.

Office Furniture                                                100

Cash                                                                                                     100

In the above example, an increase in an asset of furniture is debited by $100. This has been paid for by cash which leads to a reduction in another asset class and is recorded by crediting the cash account.

  • Purchase of Goods worth $250 on credit

 

Double Entry:                                                     Dr.                          Cr.

Goods                                                                   250

Creditor/payable                                                                               250

Buying goods on credit increases an asset i.e. goods, this increase is recorded by debiting asset account. We still have to pay for the goods and this gives rise to a liability. This increase in liability is recorded by crediting the creditor account.

  • Owner contributes $1000 to the business bank account.

 

Double Entry                                                      Dr.                          Cr.

Bank                                                                      1000

Equity                                                                                                   1000

The contribution made by the owner increased one asset i.e. bank and hence the corresponding entry is reflected by debiting the bank account. An increase of $100.00 has also occurred in the owner’s equity, we now know from the table provided above that an increase in equity is credited.

  • Cash Sale of goods worth $150.

 

Double Entry                                                      Dr.                          Cr.

Cash                                                                      150

Sales                                                                                                      150

In the example above, there is an increase in both the revenue and asset accounts. The recording is again based on the information provided in the table above where it can be seen that an increase in asset is debit and an increase in Revenue is credit.

  • Paid Monthly utility bill of $70

Double Entry                                                      Dr.                          Cr.

Utility Expense                                                  70

Cash                                                                                                      70

In the case of paying utility bills, the utility expense increases and the payment made by an asset decreases the asset account. Double entry to reflect this transaction is debited by expense as it increases and credited to asset as the asset decreases.

These are just a few examples of financial transaction that happen in an organization. There are numerous transactions happening in businesses every day but the underlying concept for every transaction is the same. Understanding how to use debits and credits can be confusing but always remember that for every transaction there has to be at least one debit and one credit, which can be in the same account category or different ones.

Get our FREE Accounting Spreadsheets Now!