Asset accounts will typically have debit balances whereas liabilities and owners' equity accounts will typically have credit balances. In addition to assets equaling liabilities and owners' equity, debits should always equal credits.
- Instead of using the terms left and right to indicate which side of a T account is affected, terms unique to accounting were developed: debit, abbreviated DR, is used to indicate the left side of the T account, and credit, abbreviated CR, is used to indicate the right side of a T account. Debit means left, credit means right. Nothing more, nothing less. Let me say that again. Debit means left and credit means right. Now, in addition to representing the left and right side of an account, the terms debit and credit take on additional meaning when coupled with specific accounts. By convention, for asset accounts, debits refer to increases. And credits refer to decreases. For example, to increase the cash account, we debit it. To decrease the cash account, we credit it. Since we expect the total increases in cash to be greater than the decreases, the cash account will usually have a debit balance after accounting for all transactions. Thus, we can make this generalization. Asset accounts will usually have debit balances. That is, their balance will typically be on the left side of the T account. Now, the opposite relationship is true for liability and owner's equity accounts. They are decreased by debits and increased by credits. As a result, liabilities and owner's equity accounts will typically have credit balances. In addition to assets equaling liabilities and owner's equity, debits should always equal credits. If you fully grasp the meaning of these two equalities, you are well on your way to mastering the mechanics of accounting or learning the language of accounting. Debits and credits allow us to take a shortcut to ensure that the accounting equation always balances. If for every transaction debits equal credits, then the accounting equation will always balance. To understand why this is, keep in mind three basic facts regarding double entry accounting. First, debits are always added on the left side of an account, and credits on the right side. Second, for every transaction, there must be at least one debit and one credit. And third, debits must always equal credits for every transaction. If you can grasp these three points, you're well on your way to understanding the mechanics of accounting.
- Identify how a balance sheet reflects the accounting equation.
- Name the account where debits are increases and credits are decreases.
- Define a journal.
- List the three things, in order, that you must address when making journal entries.
- Explain the function of financial statements that is most important for entrepreneurs.
- Assess the purpose of a trial balance.