Basic Financial Statements
Double Entry Accounting
Double Entry Accounting and The Accounting Equation
In double entry accounting, for every debit there must be an offsetting credit. One helpful tool to understanding debits and credits might be to think in terms of the left and right side of the accounting equation. The left side represents the assets of the company and the right side represents the claims on those assets; i.e., liabilities and owners' equity. Generally, anything that increases the left side or decreases the right side would be considered a debit and anything that increases the right side or decreases the left would be considered a credit.
As previously illustrated, revenues and expenses may also be thought of in terms of the accounting equation. Since owners' equity is a claim on assets, it would therefore fall on the right-hand side of the equation. Revenues would be considered credits because, in essence, they would eventually tend to increase ownership in the business. Expenses would take away from the ownership and so they would fall on the left-hand side of the equation.
Debits and Credits, and the Left–Right Notion
Increases in Assets
Decreases in Claims
Liabilities + Owners' Equity
Decreases in Assets
Increases in Claims
This "left–right" notion carries through into journal entries where the debit is recorded on the left side of the transaction and credits are recorded on the right. An example of this "left–right" thinking may be constructed using an example where a $500 materials expense which was charged on a trade account is to be recorded. The expense would eventually decrease ownership in the company when it is paid. It therefore would impact on the left side of the accounting equation, so it would be a debit.
The charging of the materials would be an increase in a liability (accounts payable). That increases the claims on the company, so it would be considered a credit. The journal entry to record this transaction would be:
Note that the debit appears first and the dollar amount appears on the left side of the journal entry. The credit is listed second and appears on the right-hand side.