As bookkeepers it is essential that we understand double entry bookkeeping. This means we need to know which accounts are debit balance accounts and which are credit balance accounts and how they are affected by different transactions. For example, when we put money into an asset account such as a bank account, it is a debit to that account. When we take money from that same asset account it is a credit. When we make a payment on a liability it is a debit to that account, while an increase to amount owed for that liability account is a credit.
Debits and credits in bookkeeping can be a difficult concept to grasp especially in the beginning. You might have heard that the total of all debits must equal the total of all credits in a bookkeeping system.
DEBITS = CREDITS
These are the two sides of the balance sheet. Just as the two sides of a scale balance when each side has an equal amount.
Debit Accounts are the asset accounts of the General Ledger.
Credit Accounts consist of the liability and capital (investment and earnings) accounts.
Therefore, just as debits must equal credits, so must assets equal the total of liabilities, capital and accruals.
ASSETS = LIABILITIES + CAPITAL + ACCRUALS
How debits and credits affect Debit Accounts:
A debit to a debit (asset) account increase the amount of that account.
A credit to a debit (asset) account decreases the amount of that account.
How debits and credits affect Credit Accounts:
A debit to a credit (liability & capital) account decreases the amount of that account.
A credit to a credit (liability & capital) account increases the amount of that account.
Another way to state the relationship between debits and credits is to say that assets are what we own and liabilities, accrual and capital accounts are the source of what we own. In simple terms, if we buy a computer for our business with a loan, that asset (computer) comes from the liability that loan becomes. That would result in a debit to our asset account and a credit to our liability account.
A Difficult Concept
Probably the most difficult concept to grasp in accounting is double entry bookkeeping. I certainly struggled the first time I worked with it in the professional bookkeeper’s course I took. Because I had used software in my early years as a bookkeeper, I was mostly unaware of the term debits and credits.
In accounting software, most of the work of entering debits and credits are performed by the software program, while the user makes only one entry for each transaction. The software creates the double entry behind the scenes.
Each type of balance sheet account in the General Ledger has either a debit balance or a credit balance. Typically, Asset and Expense accounts have debit balances, and Liability, Capital and Accrual accounts have credit balances. Therefore Asset and Expense accounts are called debit accounts, whereas the other three are called credit accounts.
Discovering mistakes is made much easier with double entry bookkeeping because every entry to one account must have an equal entry in an opposite account. Anytime something gets out of balance, you know that a mistake has been made somewhere in the accounting.
When using ledgers instead of software, you work with T-accounts. Debits are on the left side and credits are entered on the right.
Double Entry Bookkeeping for Asset and Earnings Accounts
Debits increase the value of Asset accounts.
Credits decrease the value of Asset accounts.
Debits decrease the value of Earnings accounts.
Credits increase the value of Earnings accounts.
Double Entry Bookkeeping for Office Expense
In bookkeeping where a business keeps a set of physical ledgers, every entry in the books requires another opposite entry somewhere else in the books. A credit to one balance sheet account in the General Ledger, requires a debit in another. For example, if you buy paper for your company printer using funds from the checking account, you would:
1) enter the amount on a line in your checking account ledger, showing a decrease, or credit to your Business Checking (Asset) account, and then you would
2) enter the same amount as a decrease, or debit to your Earnings account. The decrease to Earnings came from the Office Expense for paper because:
Expenses decrease earnings.
The above example uses a bank account, which is referred to in bookkeeping as an Asset account. A debit to an asset account increases the value of that account (checking in our example). A credit decreases the value of that same asset account.
In the double entry bookkeeping example above, you might notice that when money was taken from the checking account, the entry was called a credit. This same transaction was a debit to the banks accounting system.
Let’s take a look at this from the bank’s point of view. When you take money out of your account, it is a debit to the bank, and when you put money in to your account, it is a credit to the bank. That is why the bank tells you that your account was debited when they charge you fees.
Double Entry Bookkeeping for Asset and Accrual Accounts
Debits increase the value of Asset accounts.
Credits decrease the value of Asset accounts.
Debits decrease the value of Accrual accounts.
Credits increase the value of Accrual accounts.
Double Entry for Office Furniture Expense
Let’s imagine that you have purchased a desk for your office at an expense to the business of $840. You would:
1) enter a credit of $840 to your business checking account (Current Asset), decreasing the amount of money in that asset account
2) enter a debit of $840 to your PP&E (Property, Plant & Equipment) Fixed Asset account, increasing the value of that account.
In this example, you would not enter a debit of $840 to your earnings account, because your office desk must be depreciated using the appropriate depreciation schedule. The expense could not be fully accounted for in the year the desk was purchased.
Double Entry for Depreciation Expense
Now let’s enter the first months’ depreciation expense.
1) enter a credit of $10 to your Accumulated Depreciation (Accrual) account, increasing the amount of that account.
2) enter a debit of $10 to your Earnings account, decreasing the amount of that account.
As you can see from our example here, the office furniture expense only affected the Earnings General Ledger account at the time the Accumulated Depreciation was accounted for.
Double Entry Bookkeeping for Liability and Earnings Accounts
Debits decrease the value of Liability accounts.
Credits increase the value of Liability accounts.
Debits decrease the value of Earnings accounts.
Credits increase the value of Earnings accounts.
It is payday and you want to write a paycheck for your employee in your double entry bookkeeping system.
Every time you write a check to your employee, funds will come out of your business bank (Asset) account and you will also owe money to different government tax agencies. In double entry bookkeeping terms, you now have payroll tax liabilities.
Let’s say that your employee earned gross wages of $1,000 this pay period. You calculate how much to withhold from your employees paycheck to arrive at his/her net pay. The money you withheld from the earnings is a liability owed by your company to the government. Here are the calculations for your double entry bookkeeping system:
$1,000.00 – Gross Payroll
-$50.00 – Federal Withholding
-$62.50 – Social Security
-$14.50 – Medicare
$873.00 – Net Pay
After calculating withholdings and net pay you make the following credit entries:
1) a credit of $873.00 to your Business Checking account, showing a decrease in the checking account balance
2) a credit of $50.00 to your Federal Withholding Liability account increasing that liability
3) a credit of $62.50 to your Social Security Liability account, increasing that liability
4) a credit of $14.50 to your Medicare Liability account, increasing that liability
Now that you have accounted for the $1,000 gross earnings of your employee on the credit side of the equation in your bookkeeping, you must account for the same amount on the debit side of the equation. As a result, you will make the following bookkeeping entries:
5) a debit of $1,000 to your earnings account on the balance sheet, showing a decrease in the earnings of your company.
At this point you still have $127.00 in payroll tax liability that you will deposit by the due date. When the time comes to make your federal payroll tax deposit, you will make the following bookkeeping entries:
1) a debit of $50.00 to your Federal Withholding Liability account decreasing that liability
2) a debit of $62.50 to your Social Security Liability account, decreasing that liability
3) a debit of $14.50 to your Medicare Liability account, decreasing that liability
and
4) a credit to your checking account of $127.00, decreasing the amount of money in that asset account
Since the federal government requires that your business match the Social Security and Medicare amounts, your business owes an additional $77.00 in payroll tax liabilities. You will make the following bookkeeping entries:
1) a credit of $62.50 to your Social Security Liability account, increasing that liability
2) a credit of $14.50 to your Medicare Liability account, increasing that liability
And again, when you pay this tax in your federal tax deposit, you will make the following bookkeeping entries:
1) a debit of $62.50 to your Social Security Liability account, decreasing that liability
2) a debit of $14.50 to your Medicare Liability account, decreasing that liability
This example applies to your state payroll liabilities as well.