Debits and credits – what are they and what do they mean?

Debits and credits are the names given to each side of a double-entry bookkeeping transaction. Business transactions are stored in records or ‘accounts’ whereby similar transactions are grouped together. These accounts are made up of debits and credits and will show a balance which is total debits less total credits (this may be zero in some cases).

By convention debits are on the left and credits on the right (or sometimes shown as positive or negative numbers respectively). This is purely for consistency and ease of use and does not in itself have any meaning.

As the system has to have a point of origin, assets are debits and liabilities credits. This doesn’t mean you can’t post the credit side of a journal to an asset account – you can, it just means that it is a reduction in the book value of the asset (most likely depreciation). Similarly you can debit a liability, which reduces the value of that liability – such as a payment to a creditor reducing what you now owe to them. Equity (or Capital) is usually treated as a separate category but it is really just a (non-current) liability of the business to the owner or shareholders.

OK, so that is the balance sheet side of double entry but because it is a self-balancing system the principal equally applies to the profit and loss account. Here debits are costs or overheads and credits are income or revenue – you can think of it as income being an increase in owner’s equity.

DEBIT	CREDIT
Asset	Liability / Equity
Reduce Liability	Reduce Asset
Expense	Income
Reduce Expense	Reduce Income

A frequent comment on this is “but I have a positive bank balance which is in credit”. This does cause considerable confusion, as it is where most business owners are likely to come across the debit/credit terminology. It is not a contradiction – to the bank your bank account is a liability, they owe you that money. It is perhaps just egocentric of them to display information to the customer from the banks point of view.

A more helpful way to look at this is to equate it with buying something on credit which is very common and easily understood. In bookkeeping parlance you are crediting your general ledger credit card account and debiting whatever the transaction was – either an asset or an expense.

The terminology is often abbreviated as debit (Dr.) and credit (Cr.). An example of a journal transaction as it would be written or posted to a ledger account – an electronic bank payment to pay for a reference manual:

Dr.	6-3300	Books & Periodicals	$50.00
Cr.	1-2010	Bank Account		$50.00

The above codes are fictitious and will depend on the structure of the chart of accounts – which will be subject of a future post…..