Debit vs. credit accounting: your business’s complete guide
In the world of accounting, few concepts are as fundamental as the dynamic duo of debits and credits. But what exactly does it mean to “debit” or “credit” an account? And why is it so important to grasp the distinctions between these two accounting methods?
Here, we break down debit and credit accounting so you can master financial management, keep your books balanced, and see your business thrive.
Understanding debits and credits in accounting
In accounting, debits and credits are the fundamental tools for keeping your business's financial records in order. They record incoming and outgoing cash flow on your financial statements, ensuring entries stay aligned.
So, what’s the difference between a debit and a credit? In double-entry accounting — a system where every financial transaction is recorded in at least two accounts to maintain balance and accuracy — debits record incoming money and credits record outgoing money. Every time you debit one account, you also need to credit the same amount from another account.
What is a debit?
A debit is an accounting entry that records incoming cash — increasing asset and expense accounts and decreasing liability, equity, and revenue accounts. If you don’t know what any of those are, don’t worry. We’ll break down these accounts in more detail later on.
What is a credit?
A credit is an accounting entry that records outgoing cash — increasing liability, revenue, or equity accounts and decreasing asset or expense accounts.
Understanding how to implement debit vs. credit accounting
Now that we've grasped the basics, let's explore how to implement both debit and credit accounting and what each method does for your books and your business.
Debits and credits affect accounts in different ways
This is where it can get tricky. Credits and debits can both increase and decrease the balances of different types of accounts, so it’s important to have a grasp on the accounts that you’re working with and what credits and debits do to each. Let’s break this down.
Asset accounts represent the valuable resources a company owns, like cash, accounts receivable, inventory, and property — all poised to deliver future economic benefits.
Debits increase asset accounts because they represent an infusion of value, whether it’s cash received or inventory purchased.
Credits decrease asset accounts, reflecting the outflow or consumption of resources.
Liability accounts reveal what a company owes — be it credit card balances, accounts payable, or loans.
Credits increase liability accounts because they signify an obligation or debt incurred by the company.
Debits decrease liability accounts, indicating payments or reductions in what the company owes.
Equity accounts exhibit the stakeholders' claim on the company’s assets, encompassing stocks, retained earnings, and capital contributions.
Credits increase equity accounts, mirroring the injection of value from investors or retained profits.
Debits decrease equity accounts, representing withdrawals, dividends, or losses.
Revenue accounts capture the inflow from operating and nonoperating activities, such as sales or investment income.
Credits increase revenue accounts as they represent earnings and income generated.
Debits decrease revenue accounts, accounting for refunds, discounts, or any deductions from the total income.
Expense accounts tally the costs of running a business, like salaries, rent, or advertising.
Debits increase expense accounts, reflecting the consumption of resources or services.
Credits decrease expense accounts, which might occur in adjustments or reversals of previously recorded expenses.
Debit and credit examples
Let’s review what we’ve learned about debits and credits so far:
Debit accounting and credit accounting are opposite but equal sides of the same coin.
As one action increases or decreases the amount in one account, the other must increase or decrease the same amount in another account.
Debits and credits behave differently based on the account the cash is coming in or out of.
Here are some examples to help you make sense of the madness:
Documenting employee salary payments: Sarah's boutique has to pay its employees their monthly salaries, totaling $8,000. By paying the salaries, Sarah's cash asset decreases while her salary expense increases. To note this on her general ledger, Sarah would record an $8,000 debit in her expense account (decreasing the amount) and an $8,000 credit in her asset account (increasing the amount).
Documenting equipment depreciation: In this scenario, an IT company is documenting the depreciation of its computer equipment, which is an annual expense of $3,000. The value of the equipment decreases, and the depreciation expense increases. To note this, the company would record a debit of $3,000 in their expense account (noting the depreciation expense and decreasing the amount) and record a credit of $3,000 in their asset account (noting accumulated depreciation and increasing the amount).
Documenting purchase of goods on credit: In this scenario, Bob's hardware store purchases inventory worth $2,000 on a company credit card. Both the inventory and accounts payable would increase because the amount is yet to be paid. Because of this, Bob would record a $2,000 debit in his asset account (increasing the amount) while also recording a $2,000 entry in his liability account (also increasing the amount).
Challenges and best practices in debit and credit accounting
While debit and credit accounting is indispensable for accurate financial record-keeping, it doesn't come without challenges. Here are some common hurdles and best practices to keep your books balanced:
Complexity: Double-entry accounting can be complex and time-consuming. Taking advantage of accounting software can simplify the process. Another pro tip? Use expense management software with accounting integrations so all your spend management processes are automated, streamlined, and error-free.
Human error: Mistakes in recording debits and credits can lead to imbalanced books, which is any accountant's worst nightmare. Your accounting and expense management software can help with this, but regular audits and reconciliations are also important to ensure you’re staying compliant.
Understanding implications: It's crucial to understand how debits and credits affect different accounts. If you need a hand, consider partnering with outside accountants to be sure each transaction is properly recorded.
Balance your books and grow your business with Expensify
Understanding and effectively implementing debits and credits is a must to maintain accurate financial records. The key to balanced books is consistency and clarity in recording every transaction with precision — even when it’s complicated.
Expensify can help you keep your credits and debits in check by integrating with your accounting software, streamlining expense management, and ensuring your books are error-free. By embracing the right tools and practices, you can guarantee that your business's financial health is always in check, paving the way for growth and success.
