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FAQ

These are the backbone of any accounting system. Understand how debits and credits work and you'll understand the whole system. Every accounting entry in the general ledger contains both a debit and a credit. Further, all debits must equal all credits. If they don't, the entry is out of balance. That's not good. Out-of-balance entries throw your balance sheet out of balance.

Therefore, the accounting system must have a mechanism to ensure that all entries balance. Indeed, most automated accounting systems won't let you enter an out-of-balance entry-they'll just beep at you until you fix your error.

Depending on what type of account you are dealing with, a debit or credit will either increase or decrease the account balance. The table below illustrates the entries that increase or decrease each type of account.

 

Account Increase Decrease

Assets

Debit +

Credit -

Cost of Goods Sold

Debit +

Credit -

Expenses

Debit +

Credit -

Liabilities

Credit -

Debit +

Capital

Credit -

Debit +

Retained Earnings

Credit -

Debit +

Sales & Adjustments

Credit -

Debit +

Other Income & Expenses

Credit -

Debit +

 

Notice that for every increase in one account, there is an opposite (and equal) decrease in another. That's what keeps the entry in balance.

Let's take a look at two sample entries and try these debits and credits:

Example:

In the first stage of the example we'll record a credit sale:

Accounts Receivable $1,000
Sales Income $1,000

If you looked at the general ledger right now, you would see that receivables had a balance of $1,000 and income also had a balance of $1,000.

Now we'll record the collection of the receivable:

Cash $1,000
Accounts Receivable $1,000

Notice how both parts of each entry balance? See how in the end, the receivables balance is back to zero? That's as it should be once the balance is paid. The net result is the same as if we conducted the whole transaction in cash:

Cash $1,000
Sales Income $1,000

Of course, there would probably be a period of time between the recording of the receivable and its collection.

That's it. Accounting doesn't really get much harder. Everything else is just a variation on the same theme. Make sure you understand debits and credits and how they increase and decrease each type of account.