Meaning of Debit and Credit in Accounts

Debits and credits are the backbone of modern accounting principles and economies. Without them, there would be no financial statement available, no possibility of financial analysis and no investment valuation. Bookkeepers record business activities by debiting and crediting specific accounts based on generally accepted accounting policies (GAAP), company rules and regulatory standards.

Purpose

A bookkeeper records a business transaction by crediting one account and debiting another. This is called making an entry (or making a "journal" entry). A "journal" is an accounting record. The idea behind a journal entry is that an economic transaction always has a double purpose---that is, double-entry accounting principle. For example, when a customer pays for goods, the seller receives cash but "loses" the goods, and vice-versa.

Significance

The double-entry accounting principle is important because accounting rules and regulatory standards require it for companies listed on securities exchanges. Even entities that use cash accounting to record transactions, such as small businesses, follow the double-entry accounting principle. (Cash accounting does not comply with GAAP and requires debits and credits only when cash is received or paid.)

Revenues

A revenue is income from a sale or an investment. A revenue also may be a reduction of an expense. (For example, if a landlord decreases the monthly rent, the extra cash represents a revenue for the tenant.) A revenue account could be sales, interest income or commissions. Debits decrease a revenue account, and credits increase it.

Expenses

An expense is any amount paid for goods or services. An expense also may be a reduction in revenues. (For example, if a vendor sells goods at a discount, the discount amount represents an expense or a loss for the vendor.) An expense account could be cost of goods sold, salaries or interest expense. Debits increase an expense account, and credits decrease it.

Assets

An asset represents a company's resources, or what it owns. An asset that a company can sell in a year or less is a current asset (e.g., inventories); it is a long-term or fixed asset if the company intends to use it for more than a year (e.g., machines or land). Debits increase an asset account, and credits decrease it.

Liabilities

A liability represents a corporation's debt. Debt that a company must reimburse in a year or less is a current liability (e.g., salaries payable); it is a long-term liability if it is due in more than 12 months (e.g., bonds payable). Debits decrease a liability account, and credits increase it.

Owner's Capital

Owner's capital represents cash that owners (or shareholders) invest in a corporation. Examples of owners' capital accounts are dividends, retained earnings, profits and reserves. Debits decrease a capital account, and credits increase it.