Debit and Credit: Simple view of in and out

Accounts are shaped like a T that has a left side called Debit or Dr and a right side called Credit or Cr. Debit means to have, increase, go up or come in and Credit means don’t have, decrease, go down or go out. A simple way to look at it is to say Debit and Credit mean to record the items that are in and out of the business.

The terms debit and credit should be familiar to you from early so you will know how to treat accounts that are divided into assets, liabilities, income, capital and expenses. These are called ALICE accounts.

How Debit and Credit relate to in and out

Debit assets when something is in

Assets are recorded on the debit side of the T account when they increase. This means that the business benefits from something that is in it. Here is a list of increased assets in order of permanency to liquidity.

• A building that the business owns is in the business.
• Stock or inventory is goods for resale that sit on the shelves or are in the warehouse of the business.
• Prepaid expenses are bills paid in advance for goods and services to come into the business in the near future.
• Debtors owe money that suppose to come into the business in the near future.
• Cash and cheques earned, borrowed and invested come into the business.
• The bank has money that the business owns.

Credit assets when something is out

Assets are recorded on the credit side of the T account when they decrease. This means that the business is out of something. Here is a list of decreased assets in order of permanency to liquidity.

• A building sold goes out of the business.
• Stock or inventory sold goes out of the business.
• Prepaid expenses that are incurred in the relevant period go out of the business.
• Debtors go out of the business when they pay their debt or it has been written off.
• Cash or cheques spent to pay off suppliers, loans, investors and other expenses go out of the business.

Debit expenses when something is in

Expenses are recorded on the debit side of the T account when they increase. This means that the business benefits from something that is in it. Here is a list of expenses in order of operating to non-operating.

• Purchases of goods for resale comes into the business to be sold at a profit.
• Carriage inwards transports goods for resale into the business.
• Discount allowed is a tricky account when it comes to relating it to in and out. Although the business receives less money from the customer at the moment, it hopes that this act encourages the customer to bring in sales in the future.
• Carriage outwards is another tricky account when it comes to relating it to in and out. Although it transports goods out of the business to customers, it brings in cash as they pay for the transport.
• Insurance is coverage that may come into the business if there is a fire or accident.
• Advertising and marketing bring in customers with promotion and brand awareness.
• Professional fees are for services that bring in enhancement to the business.
• Utilities bring in light, water, phone and internet to the business.
• Depreciation and bad debts show a realistic value of fixed assets and debtors so investors are in favour of the business.
• Returns inwards are the goods sold to customers that they bring back into the business. This may not be in favour of the business but something comes in.

Credit expenses when something is out

Expenses are recorded on the credit side when they decrease. This means that the business is out of something. Here is a list of decreased expenses in order of operating to non-operating.

• Purchases account reduces when goods are returned to suppliers. However, the income account Returns outwards records the entry. The adjustment is shown in the Income Statement.
• Purchases account also reduces when the business receives a discount from suppliers. However, the income account Discount received records the entry. The adjustment is shown in the Income Statement.
• Insurance paid for but not used in the accounting period comes out of the expenses account with a credit entry. It may be debited in the Prepaid expense account in assets to be used in another period.
• Advertising and marketing costs may have covered a banner design which was not provided. The amount comes out of the expense account with a credit entry. The refund is debited in accounts receivable.
• Professional fees for legal services may be paid for in the accounting period but the service was never provided as the lawyer fell ill. The expense account decreases with a credit entry while the refund is recorded in accounts receivable.
• Utilities that are paid for in the accounting period but the service was never provided are usually credited in the expense account. They may be debited in the prepaid expense asset account for service in the next period or refunded to the business in the accounts receivable asset account.

Assets and expenses transactions

Assets and Expenses are treated similarly as shown above. If a business purchases furniture using cash, the furniture comes into the business and cash goes out of the business. This means that the company’s Furniture account increases and Cash account decreases. A bookkeeper records the increase of the Furniture account as a Debit entry and the decrease of the Cash account as a Credit entry.

If the business pays for services to operate, then the Expense accounts such as rent, light and repairs increase. These are debited to show that the business has a place to operate, electricity, and working machinery. If the services are cancelled and the business makes a request for a cash refund, then the Expense accounts will be credited with the same figures.

The Expense account Purchases does not record a credit balance when the business returns goods to the suppliers. Instead, the Income account Returns Outwards is credited to reduce the Purchases figure when doing the Income Statement.

Credit liabilities when something is out

Liabilities are recorded on the credit side when they increase. This means that the business is out of something as it owes someone. Here are some increased liabilities from short term to long term.

• Accrued expense means the business has an outstanding bill for a service that was used.
• Prepaid revenue means that goods are still outstanding for a customer who paid in advance.
• Creditors mean the business has an outstanding invoice with suppliers.
• Bank draft means the business is out of funds in the bank.
• Loan means the business has an outstanding bill for borrowed funds.

Debit liabilities when something is in

Liabilities are recorded on the debit side when they decrease. This means that the business benefits as the debt is reduced. Here are some decreased liabilities from short term to long term.

• Accrued expense that is paid off is in favour of the business.
• Prepaid revenue that is closed off when the customer receives the items is in favour of the business.
• Creditors that are paid off is in favour of the business.
• Bank draft that reduces is in favour of the business as money is deposited into the bank.
• Long term loan that reduces is in favour of the business as the debt becomes less.

Credit income when something is out

Income is recorded on the credit side when it increases. This means that the business is out of something in order to generate funds. Here are some increased income in order of operating to non-operating.

• Sales means goods and services go out of the business to customers.
• Returns outwards mean goods go out of the business back to suppliers.
• Revenue means goods and service go out of the business to customers and recipients.
• Discount received is a tricky account when it comes to relating it to in and out. Although the business keeps money in hand at the moment, the act may encourage the business to buy more supplies in the future, making funds go out of the business.
• Debt recovered means that payment is being made for goods or services that went out of the business in the past.

Debit income when something is in

Income is recorded on the debit side when it decreases. This means that something comes back into the business after it went out to generate funds. Income accounts however are not debited to show the decrease. Instead, expense accounts are used to do so and the adjustment is shown in the Income Statement.

• Sales account is reduced when goods are brought back into the business by customers. This is debited in the expense account Returns inwards.
• A discount on sale of goods also reduces the Sales figure. This is debited in the expense account Discount allowed.

Credit capital when something is out

Capital is recorded on the credit side when it increases. This means that the business has to make pay outs to the owner and shareholders through profits for all the assets invested into it. This is a good thing because the business is serving its purpose which is to use invested resources to make profits. Here are some increased capital.

• Invested capital – all the assets invested into a business
• Working capital – measures liquidity of the business
• Capital employed – investments used to operate the business to generate profits
• Equity – value of all fixed and current assets in the business if it was to be liquidated
• Venture capital – a short-term investment made by large investors to fund the plans of a small business or project
• Share capital – money a company raises by issuing shares

Debit capital when something is in

Capital is recorded on the debit side when it decreases. This means that the business owes less investments to the owner and shareholders. This however is not beneficial because the business has less assets with which to operate to generate income. Here are some forms of capital reduction.

• Drawings – owner takes back money invested
• Share repurchases – business buys back shares as a way of paying back shareholders
• Amortisation – business pays off a debt with regular payments

Liabilities, income and capital transactions

Liability, income and capital accounts are treated similarly as shown above. A bank loan is a liability, sale of goods is income and the owner’s investment is capital. These three accounts provide the business with cash which is an asset.

The cash is then used to pay rent or pay a light bill which are expenses. This shows why assets and expenses have debit balances and liabilities, income and capital have credit balances. The cash from the loan, sales and owner’s savings pay for the machinery and light bill to operate the business.

Another way to look at it is in order for one to HAVE one MUST NOT HAVE. If the business borrows money from the bank, liability, it means that the business HAS the cash, Asset, and the bank DOES NOT HAVE the cash anymore. The Cash account will be debited and the Bank Loan account will be credited to show that there was an increase in the amount that the business owes.

If the business sells a product for cash, income, it means that the business HAS cash, asset, but the warehouse of the business DOES NOT HAVE the product anymore. Again, the Cash account will be debited and the Sales account will be credited to show that there was an increase in sales.

If the owner invests money into the business, capital, it means that the business HAS cash, asset, but the owner DOES NOT HAVE the cash anymore. The Cash account is debited and the Capital account is credited to show that there was an increase in the money invested by the owner.