Understanding the difference between Credits and Debits

This article will help you understand an important distinction in accounting and bookkeeping- the difference between a credit and debit.


When you deposit money in the bank, the cashier will tell you "I'll credit your account." From that experience, most people assume that cash is a credit, and so credits are good. That is further reinforced when reductions in the accounts are referred to as debits. Besides, if you remove the "i" from debit, you get "debt." So, debits seem bad.

Unfortunately, the conditioning we receive at the bank is causing real confusion in the accounting class. Why? Because in accounting we understand that the bank account is a debit account, and that debts are credit accounts - the opposite of what most people expect. That is why your checking account card it referred to as a debit card.

In fact, debits and credits are neither good nor bad. Each transaction, whether it be a good transaction (deposits), or a bad transaction (bills) has both a debit and an equal credit. That's why they call it "double-entry accounting." When the cashier is telling you he or she will "credit your account", they are also entering a debit for the same amount that they are not telling you about. The same is true for the debits to your account - there is also a credit being made at the same time.

I find the best way to understand debits and credits is to identify two components of each transaction:

1. what did you get?

2. where did it come from?

The debit is what you got and The credit is the source of the item you received.
For instance, let's imagine that you purchase a computer with your credit card. Since the computer is what you received it's going to result in a debit to the asset account for your computer. The credit will be applied to the credit card liability account for the same amount.
The banks tend to confuse us because they are telling us the entry to their liability account. When you deposit money in the bank, their liability to you increases. Since liabilities are credit accounts they are crediting our account. When they reduce their liability to us, they are debiting their liability account.So, if you can identify what you received and where it came from in every transaction you have debits and credits mastered.

The Accounting Process(The Accounting Cycle)

The accounting process is a series of activities that begins with a transaction and ends with the closing of the books. Because this process is repeated each reporting period, it is referred to as the accounting cycle and includes these major steps:

1. Identify the transaction or other recognizable

2. Prepare the source document such as a purchase order or invoice.

3. Analyze and classify the transaction. This step involves quantifying the transaction in monetary terms (e.g. dollars and cents), identifying the accounts that are affected and whether those accounts are to be debited or credited.

4. Record the transaction by making entries in the appropriate journal, such as the sales journal, purchase journal, cash receipt or disbursement journal, or the general journal. Such entries are made in chronological order.

5. Post general journal entries to the ledger accounts.
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The above steps are performed throughout the accounting period as transactions occur or in periodic batch processes. The following steps are performed at the end of the accounting period:

6. Prepare the trial balance to make sure that debits equal credits. The trial balance is a listing of all of the ledger accounts, with debits in the left column and credits in the right column. At this point no adjusting entries have been made. The actual sum of each column is not meaningful; what is important is that the sums be equal. Note that while out-of-balance columns indicate a recording error, balanced columns do not guarantee that there are no errors. For example, not recording a transaction or recording it in the wrong account would not cause an imbalance.

7. Correct any discrepancies in the trial balance. If the columns are not in balance, look for math errors, posting errors, and recording errors. Posting errors include:

- posting of the wrong amount,
- omitting a posting,
- posting in the wrong column, or
- posting more than once.

8. Prepare adjusting entries to record accrued, deferred, and estimated amounts.

9. Post adjusting entries to the ledger accounts.

10. Prepare the adjusted trial balance. This step is similar to the preparation of the unadjusted trial balance, but this time the adjusting entries are included. Correct any errors that may be found.

11. Prepare the financial statements.

- Income statement: prepared from the revenue, expenses, gains, and losses.
- Balance sheet: prepared from the assets, liabilities, and equity accounts.
- Statement of retained earnings: prepared from net income and dividend information.
- Cash flow statement: derived from the other financial statements using either the direct or indirect method.

12. Prepare closing journal entries that close temporary accounts such as revenues, expenses, gains, and losses. These accounts are closed to a temporary income summary account, from which the balance is transferred to the retained earnings account (capital). Any dividend or withdrawal accounts also are closed to capital.

13. Post closing entries to the ledger accounts.

14. Prepare the after-closing trial balance to make sure that debits equal credits. At this point, only the permanent accounts appear since the temporary ones have been closed. Correct any errors.

15. Prepare reversing journal entries (optional). Reversing journal entries often are used when there has been an accrual or deferral that was recorded as an adjusting entry on the last day of the accounting period. By reversing the adjusting entry, one avoids double counting the amount when the transaction occurs in the next period. A reversing journal entry is recorded on the first day of the new period.

Instead of preparing the financial statements before the closing journal entries, it is possible to prepare them afterwards, using a temporary income summary account to collect the balances of the temporary ledger accounts (revenues, expenses, gains, losses, etc.) when they are closed. The temporary income summary account then would be closed when preparing the financial statements.