When you record an accounting transaction, you need to make a debit to one account and a credit to another. And the total amount you debited should also be equal to the amount you credited.
If you’re not familiar with the rules of debit and credit, the whole process can be tricky. If you’re new to recording transactions in your books, here’s a cheat sheet to help you understand debits and credits.
What is the Normal Balance?
All accounts — assets, liabilities, revenues, expenses, owner’s capital — have a normal balance. This normal balance could either be debit or credit.
When the normal balance of an account is debit, it will increase every time you debit that account. Meanwhile, a credit to that account will decrease the total balance.
These accounts are said to be “normal,” as debits increase and credits decrease these accounts.
Asset Accounts
All asset accounts have a normal debit balance. This means that every time you acquire an asset, you need to make a debit to that account. Alternatively, when you use, spend or dispose of an asset, you need to credit that account.
Here’s a quick example.
You paid $100,000 cash to buy land. So, to record the transaction, do the following:
Debit: Land $100,000
Credit: Cash $100,000
With this entry, you can add the land you acquired to your books. At the same time, you recorded how much cash you paid for the land.
As a result, the cash in your books will decrease and total land you own will increase.
Asset accounts include current assets including cash, accounts receivable, and inventory and long-term assets like land and equipment.
Contra-asset accounts like Accumulated Depreciation and Allowance for Doubtful Accounts have a normal credit balance.
Liability Accounts
Liability accounts which include items like loans payable and accounts payable have a normal credit balance. Every time you credit a liability account, it will increase. A debit, on the other hand, will decrease the account.
Let’s assume that you took out a $50,000 loan to buy new equipment for your business.
To record this transaction, you need to:
Debit: Equipment $50,000
Credit: Loans Payable $50,000
The debit to equipment will increase the total equipment in your books.
Since you took out a loan, you also need to record the increase in the loans your business owes. You can do this by simply debiting the loans payable account.
Revenue
Revenue accounts which include all income accounts have a normal credit balance. When you recognize income from your business, you need to credit this account.
For instance, a client paid you $5,000 for the consulting service you provided. You need to record this transaction with the following entry.
Debit: Cash $5,000
Credit: Consulting Revenue $5,000
Now, if your agreement allows the client to pay a few days later, you may record the transaction by debiting Accounts Receivable and crediting the same account Consulting Revenue.
Debit: Accounts Receivable
Credit: Consulting Revenue
Just like cash, Accounts Receivable is an asset account.
Once you receive the payment from the customer, you can record the payment through the following entry:
Debit: Cash
Credit: Accounts Receivable
Expense
Like liability accounts, expenses a normal debit balance. This means that when you record any relevant cost related to operating your business, you need to debit that account.
For instance, you received the electric bill and you paid for it right away. You can enter the transaction through this entry:
Debit: Utilities – Electricity
Credit: Cash
All other expenses such as Rent, Salaries, Repairs, and Maintenance should be debited every time you make a payment or recognize an expense.
Now, what if you did not pay an expense in cash?
If you did not pay the expense in cash but you want to record it, you can use the accounts payable account.
For instance, purchasing office supplies from a store which allows you to pay for the items at the end of the month. You can still record the entry as follows:
Debit: Supplies
Credit: Accounts Payable
When you decide to pay for the supplies, you have to make this entry:
Debit: Accounts Payable
Credit: Cash
Owner’s Capital
The owner’s capital account (Partnership Equity for partnerships and Shareholders Equity for corporations) has a normal credit balance. Any investment you put down as initial capital will be recorded in this account.
If you started the business with an initial cash investment of $20,000, you need to record the transaction through this entry:
Debit: Cash $20,000
Credit: Owner’s Capital $20,000
When you make a cash withdrawal and you don’t maintain a drawing account, you need to record the transaction as follows.
Debit: Owner’s Capital
Credit: Cash
Owner’s Drawing
Most of the time, sole proprietors who want to track their withdrawals create an owner’s drawing account. Like expense accounts, the owner’s drawing has a normal debit balance.
Each time you withdraw cash funds from your business for personal use, you need to do this entry:
Debit: Owner’s Drawing
Credit: Cash
The owner’s Drawing is only a temporary account.
At the end of the year, the owner’s drawing will be closed to the owner’s capital account.
Debit: Owner’s Capital
Credit: Owner’s Drawing
After completing this step, the Owner’s Drawing account should be zero and the Owner’s Capital should now reflect the net amount of investments and withdrawals for the year.
Dealing with Complicated Transactions
With this guide, you should be more familiar with how to record transactions in your books. You can also consult the chart of accounts if you’re not sure if an account is an asset, a liability, a revenue or an expense. But if you find the whole process tedious or too complicated, hiring a bookkeeper may be the best choice.
