Journal entries consist of two sides: debits and credits. Debits are dollar amounts that accountants post to the left side of the journal entry, and credits are dollar amounts that go on the right. Note that each journal entry records both a debit and a credit for every transaction, and the two amounts on either side must equal each other so that the fundamental accounting equation stays in balance.
For each business transaction, a journal entry shows three key aspects:
- the accounts affected
- the direction of the affect (increase or decrease)
- the dollar amount involved
Is it a debit or a credit?
Determining whether an event is a debit or a credit can be complex. Usually, one side of the transaction is obvious (e.g., when cash is received, it is an asset that increases) but it is the judgment about the nature of the other side of the entry that involves some thinking about which part of the financial statements are affected. Understanding the accounting rules that govern this process enables one to effectively encapsulate and then communicate economic events through the financial statements.
Bearing in mind the fundamental accounting equation and the need for the equation to stay in balance, the following general guidelines help clarify how a journal entry (credits and debits) is recorded:
- increases in assets and decreases in liabilities and shareholders’ equity appear on the left side of the journal entry
- decreases in assets and increases to liabilities and shareholders’ equity appear on the right side of the journal entry
- an increase in recognized revenue appears on the right as it always goes hand-in-hand with an increase in assets or a decrease in shareholders’ equities (both posted on the left side; see first bullet point)
- an increase in recognized expenses appears on the left side as it always goes hand-in-hand with a decrease in assets or an increase in shareholders’ equity (both posted on the right side; see second bullet point)
Your company pays its $500 hydro bill. It is simple to conceive you have incurred an expense (an increase of expense/utilities) of $500, and that the money in your bank account has decreased by $500 (an asset/cash decrease). To translate this to the journal entry, the increase in expense appears as a $500 debit (left side) and your decrease in assets appears as a $500 credit (right side).
Markle, K. (2004, August). Introduction to Accounting. Presentation delivered at Schulich School of Business, York University, Toronto, Canada.
Pratt, Jamie. (2003). Financial Accounting in an Economic Context. New York: John Wiley & Son.