The confusion of credit and debit is by far the list topper of the obstacles that students face. While it may seem daunting at first but as you get familiar with the language of accounting, everything starts to make sense and you will know when to credit and when to debit an account. However, there are some smart techniques that can help you understand the process in a matter of minutes.
Definition of Credit and Debit
Debit and Credit are terms used to reflect the double-sided nature of financial transactions. They are not good or bad and are just terms that describe the accounting nature of transactions to make them understandable.
For example, if a company makes a cash sale, its double-entry would be as follows.
| Cash Account | Debit |
| Sales Account | Credit |
The debit and credit in the above entry describe the transaction and any accountant will know looking at the entry that it represents a cash sale. While basic accounting entries can be easy to memorize and correlate in real-time, entries that require having moderate or advanced accounting knowledge can be challenging.
How Accounts Are Credited And Debited?
Now that we know what debit and credit are, let us get into the details of when an account is credited and when it is debited. Each class of account ie, assets, liabilities, expenses, and equity has its own underpinning rules of crediting and debiting accounts. To understand it properly, here’s what you need to keep in mind:
- Debits and Credits are neither good nor bad.
- Debits and Credits are not like addition or subtraction.
Let me first explain the credit and debit implication of each of the SIX types of accounts and then we will move on to the technique that will help you understand when do we debit and credit an account.
1. Asset Account
The natural state of the asset account is debit which means the opening balance of the asset account is written on the debit side. A debit entry increases an asset account’s balance whereas a credit entry decreases its balance. For example, if a company purchases a non-current asset, the double-entry would be:
| Non-current asset | Debit |
| Cash/Bank | Credit |
The debit entry in the above transaction reflects the fact that there has been an increase in the assets of the company whereas the credit entry describes the decrease in the company’s assets.
2. Liability Account
The natural state of the liability account is credit which means the opening balance of the liability account is written on the credit side. The credit and debit implication of liabilities is the opposite of the asset account. A credit entry increases the balance of liability accounts whereas a debit entry reduces its balance. For example, if a business purchases goods on credit, the double-entry would be:
| Purchases | Debit |
| Account Payable | Credit |
A payable is a company’s liability and in the above entry, the credit entry has increased the liabilities of the company. Let’s now look at another example that explains how a debit entry decreases a company’s liability. The company, this time, made a payment to the supplier. The double-entry will be recorded as:
| Account Payable | Debit |
| Cash/Bank | Credit |
As you can see, the debit entry describes the fact that there is a decrease in the company’s liabilities.
3. Equity Account
Like liabilities, the natural state of equity is credit and an increase in equity will result in a credit entry whereas a decrease, in a debit entry. For example, if capital is added to a new business, that is when investors invest in a company, the accounting entry would be:
| Cash/Bank (Asset) | Debit |
| Share Capital or paid-in-capital (Equity) | Credit |
As you can see, the increase in equity has resulted in a credit entry and if a decrease occurs, the equity account will be debited.
4. Expense Account
If an expense occurs, it is debited against cash or bank account. For example, if a company pays rent, the double-entry for the rent will be:
| Rent Expense | Debit |
| Cash/Bank | Credit |
5. Dividends
Dividends are debited against dividend payable when declared and when the company actually pays the dividends, the double-entry becomes:
| Dividend Payable | Debit |
| Cash | Credit |
6. Revenue
Revenue account falls under the equity and liability group and is credited against cash or account receivable when a company makes a sale. Here is the double-entry:
| Cash or A/R | Debit |
| Revenue/Sales | Credit |
When To Debit And When To Credit?
Here are some interesting mnemonics that help in knowing when to credit and when to debit a particular type of account.
D-E-A-D
D-E-A-D means debits increase expenses, assets and dividends. This mnemonic is easy to remember and apply to transactions. For example, if a company purchases an asset, you will know from the D-E-A-D that any increase in assets will result in a debit entry in the asset account. Therefore, the double-entry will be:
Asset Debit (Dr)
Cash/Bank Credit (Cr)
R-E-L-I-C
For accounts with a credit accounting nature (liabilities, equity, revenue), there is the mnemonic R-E-L-I-C that explains it pretty well. It means revenues, equity and liabilities are increased with credits. If you know the mnemonic, you won’t have to remember the credit and debit rules for each type of account, instead, apply the mnemonic.
For example, if a company makes a sale, we know that revenue has increased and will be credited as per the mnemonic. These mnemonics can be applied the other way around as well. An example would be when a company pays its debt. We know that it is a decrease in the liability account and will be debited because liabilities are credited with an increase and therefore, a decrease must result in a debit entry. The double-entry for a reduction in liability will be:
Accounts Payable Debit (Dr)
Cash/Bank Credit (Cr)
