Debits vs Credits: A Guide with Examples & How To’s

What are debits vs credits? How do they relate to each other and why are they important? 

You may not be an accountant or a bookkeeper, but it’s important to know these terms. As a business owner, this is how you know what money is coming in and what money is going out of the business. Every person, in fact, should have an understanding of this to be able to survive!

Today, we’ll be diving into these terms and their application in more detail. 

What Are Debits and Credits?

Debits and credits are terms used to describe an inflow or outflow of money from one account to another. We use this in the accrual method of double-entry accounting. We use these terms in the process of categorizing transactions and writing journal entries in a general ledger.

What Are Debits and Credits in Double-Entry Accounting?

Double entry accounting operates on debits and credits. Debits and credits operate on the principle that any business transaction impacts at least two accounts. One entry recorded as a debit in one account means a credit to another account. In other words, for every debit, there is an equal and opposite credit. When totaled, these must be equal. This is where we get the term “balancing your books”.

Debit vs. Credit: Key Differences

Debit vs. Credit: Definition and Purpose

A debit refers to money that comes into an account. A credit refers to money that goes out of an account. It’s a common misconception to think of debits as positive and credits as negative. However, these terms are only an indication of how values flow between accounts for each transaction. The purpose of debits and credits are to show the relationships between accounts. They also help provide a more comprehensive, accurate, and balanced financial record. 

Left vs. Right: Visualizing Debits and Credits

We always list debits on the left and credits on the right in a journal entry. This relates to which account balances increase/ decrease when debited or credited. One way to visualize debits and credits is through the equation:

Assets + Expenses = Liabilities + Equity + Revenue (Income) 

The balance of Asset and Expense accounts increase when debited and decreases when credited. The balance of Liability, Equity, and Revenue (Income) accounts increase when credited and decreases when debited. The natural increase/decrease of account balances due to debits and credits is what you call the normal balance of an account. So, when talking about accounts that are naturally debit vs credit, here’s the guide:

• Debit – Assets and Expenses 
• Credit – Liabilities, Revenue (Income), Equity 

Therefore, when simplified, the equation is Debits = Credits. We will visualize this more later on. 

What Are Debit and Credit Accounts?

You cannot have accounting without accounts. It is in the name. These are how a business or other entity categorizes and stores their transactions. The equation above represents the 5 main accounts. From these, we can further filter transactions into sub-accounts.  

Asset Accounts

These accounts include everything that your company owns that have intrinsic value. This includes both tangible and intangible assets. Tangible assets – Includes cash and cash equivalents, equipment and machinery, property, inventory, furniture, and stocks and other investments. Intangible assets – Intellectual property, trade secrets, copyrights, patents, trademarks 

Liability Accounts

These accounts include everything that your company owes another entity. These can be both short-term or long-term. These include taxes, loans, wages and other salaries, and other debts owed. 

Equity Accounts

Equity refers to the financial ownership interests of a company. These are the contributions invested by owners and shareholders into a business. It is what you are left with over when you subtract liabilities from assets. The remaining amount is known as the book value of a company. Equity accounts, then, represent what is owed to investors if the company were to liquidate its assets. 

Income (Revenue) Accounts

These accounts include all the money gained from both primary (operating) and secondary (non-operating) business activities. Operating Revenue is money earned through selling products or rendering services. Non-operating Revenue is income gained through non-core business activities such as investments, donations, etc.

Expense Accounts

These are accounts that include all the expenses incurred by your business. They help you track what you are spending on. These include both operating and non-operating expenses. An operating expense is any cost related to primary business operations like the sale of goods and services. For example, you would include rent, utilities, wages, supplies, and other overheads. Non-operating expenses are any costs that are related to secondary business activities. For instance, research and development, restructuring, interest costs, investment losses, are types of this.

Sub-accounts

When discussing debits vs credits, it’s also important to know sub-accounts under the main ones. Some examples of sub-accounts include:  

• Assets – Cash, Accounts Receivable, Inventory, and Equipment 
• Liabilities – Accounts Payable, Bank Loan Principal and Interest, and Credit Card Bills. 
• Equity – Owner’s Capital, Common Stock, Preferred Stock, Retained Earnings 
• Revenue (Income) – Sales Revenue, Interest Income, Dividend Income, Contra Revenue 
• Expenses – Utilities, Payroll, Rent, Income Tax Expense, and Cost of Sales (COGS). 

Note: Assets, liabilities, and equity are the three accounts you find on the balance sheet. The profit and loss statement or income statement deals with expenses and revenue. 

Examples of Debits Vs Credits 

Example 1 – Recording a Sale

Alright so, let’s say you successfully sold 10 yellow rain boots to a customer for ‌$120. Let’s indicate what accounts might be affected. Here, because it was a sale, you would credit the transaction to a Revenue account. The sub-account would likely be Sales Revenue. The paired account would be a sub-asset account. This could be your bank account or Accounts Receivable. 

Example 2 – Paying Expenses

Let’s continue the story and pretend you were the customer who bought those 10 yellow rain boots. You paid $120 dollars as a business expense. These will serve as equipment for your workers. How would debits vs credits work here? 

Here, you would be decreasing the value or crediting an asset account, namely the Bank Account. Simultaneously, you would be increasing the value or debiting your expense account, namely the Equipment sub-account.

How Do I Use Debits Vs Credits?

How to Make Entries: Debit and Credit Rules

Let’s visualize the above examples.

Journal Entries

Journal entries are ‌descriptions of your financial transactions written in a general ledger. A journal entry would look something like this:

T-Accounts

A T-Chart or T-Account is one method to show debits and credits in a transaction. Above the “T” is the name of the account. We list debits on the left of the divider and credits are on the right. You typically have two T-accounts for each transaction. The anatomy of a T-Chart can also include:

• Date of transaction
• Affected sub-account
• Amount debited or credited

If you want to see more, we go through 11 bookkeeping examples in another post. 

What Are Some Common Mistakes to Avoid with Debits and Credits?

Misunderstanding the Terms 

We mentioned this earlier, but a lot of people can get confused with the concept of debits vs credits. We can assume debits to be inherently “good” and credits are “bad”. Some take debits to mean profit and credits to mean loss when that really isn’t true. Think of debits and credits like weights on a scale. Their job is to help maintain balance. One cannot exist without the other, and they are both necessary to provide a full financial picture. 

Normal and Contra Accounts 

If you don’t memorize the natural or normal balance of accounts, it can be really easy to get confused. Let’s take revenue accounts as an example. Revenue is money flowing into a business. So, it’s easy to assume that we’d list revenue as debits since debits refer to money flowing into accounts. However, remember that revenue has a natural credit balance. Meaning we always list revenue as credit and debit a different account (such as the Bank Account). 

There are instances where a type of sub-account will have a balance contrary to their normal balance. These are called contra accounts. For revenues, you would debit a contra revenue account. Examples of contra revenue accounts include Returns and Discounts. 

Frequently Asked Questions

Do Debits and Credits always have equal values in a transaction?

Yes, this is a must! Whenever you record a debit in one account, you must also record a credit in the appropriate paired account. Otherwise, you are only recording one side of the transaction. This makes it incomplete and unbalanced. This is where the concept of “balancing your books” comes from.

Are Debits and Credits the same in every accounting system?

In single-entry accounting, you only record one entry per transaction. This means it doesn’t use debits or credits (accrual) but instead operates on a cash basis. This means listing transactions as income or expense.  For instance, if a business purchases equipment, they would list it as an expense. 

Why is it essential to understand Debits and Credits in accounting?

Grasping the concept of a debit vs credit gives you a better idea of how accounts interact with each other. Double-entry accounting which uses this is also more accurate. You can monitor your finances more effectively and make more informed financial decisions. 

What does “left side” and “right side” mean in the context of Debits and Credits?

These are terms to describe where to find/record a debit or credit. We always list debits on the left of an entry. We list credits on the right. 

What Is EcomBalance? 

EcomBalance is a monthly bookkeeping service specialized for eCommerce companies selling on Amazon, Shopify, Ebay, Etsy, WooCommerce, & other eCommerce channels.

We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.

You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.

Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.

And here’s some free resources:

• Monthly Finance Meeting Agenda
• 9 Steps to Master Your Ecommerce Bookkeeping Checklist
• The Ultimate Guide on Finding an Ecommerce Virtual Bookkeeping Service
• What Is a Profit and Loss Statement?
• How to Read & Interpret a Cash Flow Statement
• How to Read a Balance Sheet & Truly Understand It

Conclusion

Now you have a better understanding of how and when to record a debit vs credit. We know it can be a little confusing at first, but we hope this guide was a help to you!