Recording Business Transactions: Rules of Debits and Credits; T-Accounts

Recording Business Transactions: Rules of Debits and Credits; T-Account

There are very few things in accounting that I encourage my students to memorize. However, the rules of debits and credits is one that ultimately comes down to memorization. When learning the rules of debits and credits let's think about the accounting equation: Assets = Liabilities + Owners' Equity. Imagine each category of accounts as a t-account. All assets are increased with debits and decreased with credits. One asset that students sometimes has issues with is Cash. They recall that when they make a deposit into their bank account that the deposit slip states their account was credited for the amount of the deposit. What we have to understand is that the bank is keeping their books, not our books. Therefore, when you give them money, they owe that money back to you; this creates a liabilities for the bank. The account the bank is crediting is an account payable with your name on it.

Accounting Terms

An account is a detailed record of the changes in a particular asset, liability or stockholders' equity account.

The ledger is a book containing details of all accounts.

The trial balance is a listing of all the accounts with their ending balance from the ledger.

Double-Entry Accounting

There is always a giving and a receiving side during the recording of transactions. Therefore, there are always at least 2 accounts affected by any one transaction. Examples:

• Buying Land for Cash, $100,000: Giving Cash, Receiving Land 

• Sale Inventory on Account, $20,000: Giving Inventory, Receiving an Accounts Receivable 

• Purchase Equipment for Cash, $250,000: Giving Cash, Receiving Equipment

The T-Account

The left side of the t-account is the debit side and right side of the t-account is the credit side. This is always true no matter the type of account in question (i.e. asset, liability, stockholders' equity). If the left side of the t-account outweighs the right side of the t-account, it is said to have a debit balance. If the right side of the t-accout outweighs the left side of the t-account, it is said to have a credit balance.

Example Accounting Transaction

For example: Let's say you deposit $500 into your savings account. There are two parties to this transaction: you and the bank. However, this is not truly a transaction to you as you would have debited your cash account when the $500 was earned or by whatever means you received the cash.

Your entry at the time of receiving the cash, if you received it at the time of earning it, would have been:

Cash                    500                  
          Revenue               500

Once you make your deposit into the bank the BANK would have made the following entry:

Cash                    500        
          A|P                       500

Rules of Debits and Credits

The Accounting Equation

Assets = Liabilities + Owners' Equity Assets increase with debits and decrease with credits Liabilities increase with credits and decrease with debits Owners' Equity increases with credits and decreases with debits. * Everything to the left of the equal sign in the accounting equation increases with debits and everything to the right of the equal sign increases with credits. There are two accounts that act differently from other accounts that appear/affect the right side of the accounting equation.

Recall that Expenses and Dividends affect stockholders' equity indirectly and negatively through retained earnings. Because debits also make stockholders' equity decrease, expenses and dividends must increase with debits.

Examples: Cougar Cookie Company received $30,000 cash and issued common stock.

What accounts are affected and how does this affect the accounting equation?
Assets          =          Liabilities          +           Owners' Equity
 + $30,000                                                            + $30,000

Cougar Cookie Company paid dividends of $10,000. What accounts are affected and how does this affect the accounting equation?
Assets          =          Liabilities          +           Owners' Equity
- $10,000                                                            - $10,000

Normal Account Balance

Normal balance of accounts are simply what makes the account increase. For example, the normal balance of inventory is debit (i.e. assets increase with debits and therefore carries a normal debit balance). Take cash as an example: if we receive $10,000 in cash we would debit the account debits make cash increase. Therefore, we would expect cash to always have a debit (normal) balance. However, accounts payable increase with credits and we would expect A|P to always have a credit (normal) balance.