Debits Credits Basic Equation

Debits Credits

Debits & Credits

and

The Accounting Equation

Let's See How Debits and Credits are Related

To Our Accounting Equations

Remember our Accounting Equations ?

Abbreviated or Simple Version:

Property = Property Rights

and our

Expanded Version:

Assets = Liabilities + Owner’s Equity

These versions of the accounting equation simply state that assets, also called property, equals what is owed to creditors (liabilities) and the owners (owner’s equity). Liabilities and Owner’s Equity are also called property rights.

How do Debits and Credits relate to our Accounting Equations ? They’re the tools used to keep our equations balanced.

The Balance of the Left Side of the Equation (Asset Accounts) will normally have a DEBIT Balance and the Balance of the Right Side (Liability and Permanent Equity Accounts) will normally have a CREDIT Balance.

Left Side =	Right Side
Property =	Property Rights
Assets =	Liabilities +	Owner's Equity
Debit Balances =	Credit Balances +	Credit Balances
Debit Increases	Credit Increases
Credit Decreases	Debit Decreases

Notice in our table that a debit increases the balances on the left side of the accounting equation (assets) and has the opposite effect and decreases the balances on the right side of the equation (liabilities and owner’s equity). Likewise, a credit decreases the balances on the left side of the accounting equation (assets) and has the opposite effect and increases the balances on the right side of the accounting equation (liabilities and owner’s equity).

Generally, anything that increases the left side of the equation (assets) or decreases the right side of the equation (liabilities and equity) is considered a debit and anything that increases the right side of the equation (liabilities and equity) or decreases the left side of the equation (assets) is considered a credit.

What we’re doing here is relating the types of accounts (assets, liabilities, owner’s equity, revenue, expense, and draws) and the terms increases and decreases to the terms debits and credits. The terms debit and credit by themselves do not mean an increase or a decrease. The terms have to be associated with the types of accounts in order to gain their meaning.

In other words, whether a debit or credit is an increase or decrease depends on the type of account.

Before we continue our discussion of debits and credits, let’s take a look at how the terms are used with the major types of accounts. First we’ll discuss assets, liabilities and owner’s equity and then revenue, expense, and draws.

They say a picture’s worth a thousand words !

Let’s revisit our Expanded Accounting Equation Types of Transactions Table used in a prior lesson and modify it slightly to include our new terms debit and credit. Our following new table illustrates the types of transactions that can occur and the effects of debits and credits on our expanded accounting equation.

Assets =	Liabilities + Owner's Equity	Types Of Transactions Examples-See Transaction Number in Table Below
Left Side =	Right Side
(a) Increase In Assets Debit	(a) Increase In Liabilities or Owner's Equity Credit	#1, #2, #4, #5, #10
(b) Decrease In Assets Credit	(b) Decrease In Liabilities or Owner's Equity Debit	#3, #6, #7
(c) Increase In One Type Of Asset Debit		#8
(c) Decrease In Another Type Of Asset Credit		#8
	(d) Increase In One Type Of Liability or Owner's Equity Credit	#9
	(d) Decrease In Another Type Of Liabilty or Owner's Equity Debit	#9

Take note, this small table illustrates that each transaction is recorded by using a debit and a credit:

Transaction Type (a) Increases an Asset Account on the Left Side using a Debit and

Increases a Liability or Owner’s Equity Account on the Right Side using a Credit.

Transaction Type (b) Decreases an Asset Account on the Left Side using a Credit

and Decreases a Liability or Owner’s Equity Account on the Right Side using a Debit.

Transaction Type (c) Increases an Asset Account on the Left Side using a Debit and also

Decreases an Asset Account on the Left Side using a Credit.

Transaction Type (d) Increases a Liability or Owner’s Equity Account on the Right Side using a Credit and also Decreases a Liability or Owner’s Equity Account on the Right Side using a Debit.

The result of this debit and credit “scheme” is that the accounting equation will always be in balance.

Transaction Analysis Using The Simple (Abbreviated) and Expanded Accounting Equations and Debits and Credits

Let’s also revisit the tables from a prior lesson where we analyzed the effects of business transactions on the accounting equation. In that lesson we had a table analyzing transactions using the simple or abbreviated accounting equation and another table that used the expanded accounting equation. This table presents both accounting equations in one table and adds our terms debit and credit to illustrate the effect of debits and credits on our accounting equations.

Simple Abbreviated Accounting Equation	Property =		Property Rights
Expanded Accounting Equation	Assets =		Liabilities +		Owner's Equity
Side of the Accounting Equation	Left Side =		Right Side
Increase/Decrease Columns	Increase	Decrease	Decrease	Increase	Decrease	Increase
Our New Terms In Action	Debit	Credit	Debit	Credit	Debit	Credit
Description of Transactions and Their Effects On The Equation
1. ABC mows a client's yard and receives a check from the customer for $50 for the service provided. The asset cash is increased and the owner's equity is increased.	50					50
Transaction Type (a) Increase In Assets-Debit and Increase In Owner's Equity-Credit
2. ABC purchases $100 worth of office supplies for inventory and stores them in their storage room. The office supply store gives them an invoice that allows them to pay for them in 15 days (on account). The asset office supplies is increased and the liabilities are increased.	100			100
Transaction Type (a) Increase In Assets-Debit and Increase In Liabilities-Credit
3. ABC places an ad in the local newspaper receives the invoice from the supplier and writes a check for $25 to the newspaper. The asset cash is decreased and the owner's equity is decreased.		25			25
Transaction Type (b) Decrease In Assets-Credit and Decrease In Owner's Equity-Debit
4. ABC purchases five mowers for $10,000 and finances them with a note from the local bank. The asset equipment (mowers) is increased and liabilities are increased.	10000			10000
Transaction Type (a) Increase In Assets-Debit and Increase In Liabilities-Credit
5. ABC mows another customer's yard and sends the customer a bill (invoice) for $75 for the service they performed. They allow their customer 10 days to pay them for this service (on account). The asset amounts owed by cusctomers is increased and owner's equity is increased.	75					75
Transaction Type (a) Increase In Assets-Debit and Increase In Owner's Equity-Credit
6. The owner of ABC needs a little money to pay some personal bills and writes himself a check for $500. The asset cash is decreased and owner's equity is decreased.		500			500
Transaction Type (b) Decrease In Assets-Credit and Decrease In Owner's Equity-Debit
7. ABC pays the office supply company $100 with a check for the office supplies that they charged (promised to pay). The asset cash is decreased and the liabilities are decreased.		100	100
Transaction Type (b) Decrease In Assets-Credit and Decrease in Liabilities-Debit
8. ABC receives a check from the customer who they billed (invoiced) $75 for services and allowed 10 days to pay. The asset cash is increased and the asset amounts owed by customers are reduced. This is actually a swap of one type of asset for another.	75	75
Transaction Type (c) Increase In One Type Of Asset-Debit and Decrease In Another Type Of Asset-Credit
9. ABC purchased some mulch for $60 and received an invoice from their supplier who allows them 15 days to pay. The mulch was used on a customer's yard. The liability an amount owed a supplier is increased and the owner's equity is decreased.				60	60
Transaction Type (d) Increase In Liabilities-Credit and Decrease In Owner's Equity-Debit
10. ABC bills (prepares an invoice) the customer $80 for the mulch and mowing his yard and receives a check for $80 from the customer. The asset cash is increased and the owner's equity is increased.	80					80
Transaction Type (a) Increase In Assets-Debit and Increase In Owner's Equity-Credit

Totals	$10,380 Increase	$700 Decrease	$100 Decrease	$10,160 Increase	$585 Decrease	$205 Increase
Net Change	$9,680 Increase			$10,060 Increase	$380 Decrease
Total Net Changes	$9,680 Increase			$9,680 Increase

Let's see if you've been fibbing to me about those debits and credits.

Account Type	Debits	Credits
Asset Transactions	10,380	700
Liability Transactions	100	10,160
Equity Transactions	585	205
Totals	11,065	11,065

By golly those debits and credits do equal each other.

Let’s not forget “Ma Capital’s (Owner’s Equity) Kids” ! We also borrowed another table from a prior lesson and included the terms debit and credit in the table.

Equity Table

Analysis of the Effects of Debits and Credits and Revenue, Expense, and Draws on Owner’s Equity

In the previous table, we entered all the transactions that affected Owner’s Equity under one heading; namely, Owner’s Equity and disregarded whether it was a revenue, expense, or draw item. The following table illustrates where the transactions affecting Owner’s Equity would actually be entered.

Instead of recording transactions directly to Owner’s Equity (“Ma Capital”), proper bookkeeping actually uses her “Kids” Revenue, Expense, and Draws to record the increases and decreases to “Ma Capital” (Owner’s Equity) in order to provide us with the answers to the how and why the owner’s claim to the business’s property increased or decreased.

This table also illustrates the effects of debits and credits on “Ma Capital’s Kids” Revenue, Expense, and Draw. Of course only the sample transactions that affect Owner’s Equity (Revenue, Expense, and Draws) have been included.

Equity Table
Effects Of Revenue, Expense, & Draws on Owner's Equity	Owner's Equity "Ma Capital"		"Ma's Kids"
Proper Recording Actually Uses Revenue, Expense & Draws Instead Of Owner's Equity	Original Recording		Proper Recording Uses
Transactions	Owner's Equity Right Side		Revenue	Expense	Draws
	Decrease	Increase	Revenue Increases Resulting In an Increase to Equity	Expenses Increase Resulting In a Decrease to Equity	Draws Increase Resulting in a Decrease to Equity
Our New terms In Action	Debit	Credit	Credit	Debit	Debit
1. ABC mows a client's yard and receives a check from the customer for $50 for the service provided. The asset cash is increased and revenue is earned.		50	50
3. ABC places an ad in the local newspaper receives the invoice from the supplier and writes a check for $25 to the newspaper. The asset cash is decreased and the owner's equity is reduced due the increase in expenses incurred.	25			25
5. ABC mows another customer's yard and sends the customer a bill (invoice) for $75 for the service they performed. They allow their customer 10 days to pay them for this service (on account). The asset amounts owed by customers is increased and revenue and owner's equity are increased.		75	75
6. The owner of ABC needs a little money to pay some personal bills and writes himself a check for $500. The asset cash is decreased and the owner's equity is decreases resulting from the increase in owner's draws.	500				500
9. ABC purchased some mulch for $60 and received an invoice from their supplier who allows them 15 days to pay. The mulch was used on a customer's yard. The liability amount owed a supplier is increased and the owner's equity is decreased resulting from the increase in expenses.	60			60
10. ABC bills (prepares an invoice) the customer $80 for the mulch and mowing his yard and receives a check for $80 from the customer. The asset cash is increased and the revenue and owner's equity are increased.		80	80

What should we pick up and learn from these tables and example transactions recorded in the tables ?

Here’s What

1. How different types of business transactions affect the Accounting Equation.

2. How it associates increases and decreases and the types of accounts with the terms debits and credit.

3. How each transaction was recorded twice illustrating double entry bookkeeping.

4. The total amounts for the tables prove the self-balancing nature of the Accounting Equation.

5. How transactions may require increases to both sides of the equation (increase left side using a debit and increase right side using a credit ), decreases to both sides of the equation (decrease left side using a credit and decrease right side using a debit ), or an increase and decrease on the same side of the equation (increase using a debit and decrease using a credit on the left side or increase using a credit and decrease using a debit on the right side of the equation ), but the equation must always balance.

6. The Equity Table illustrates that, while transactions that affect Owner’s Equity could be entered using only one column, additional useful information is obtained by breaking Owner’s Equity into its component parts (kids) using the revenue, expense, and draws categories to record the transactions.

(a) That revenues increase owner’s equity while expenses and draws decrease owner’s equity.

(b) It illustrates that we could use only the Main Account Types Assets, Liabilities, and Owner’s Equity (Capital) contained in our Basic Expanded Accounting Equation (Assets = Liabilities + Owner’s Equity) to record our transactions and not use “Ma Capital’s Kids” – Revenue , Expense , and Draws .

The drawback of just using “Ma Capital” (the Owner’s Equity Account) is that the Owner’s Equity (Capital) Account would require a great deal of analysis and time in order to determine the income or loss for a period and the reasons for this income or loss.

From here on out , transactions will be recorded using “Ma’s Kids” revenue, expense, and draws.

Take the Plunge ! Can you guess what we’re going to discuss next ?

How about the Fully Expanded Version of our Accounting Equation and debits and credits.