Debits and credits are a key concept in accounting, and underlie the double entry bookkeeping process. So if you’ve started thinking about a career in accounting, or work in a finance-related environment, you’ve probably heard them mentioned.
Let’s take a look at what debits and credits are, and how they apply in different contexts.
A balancing act
Debits and credits refer to adding or taking away funds from accounts. Any transaction that takes place affects two or more accounts, with at least one being debited and one being credited. For each transaction, debits and credits need to be equal.
You will make entries into an account’s ledger differently depending on whether it is a debit or a credit. Debit entries appear in the left hand column, while credit entries appear in the right hand column.
Debits and credits affect accounts in different ways:
Debits increase and credits decrease the following accounts: purchases, expenses, and assets.
Credits increase and debits decrease the following accounts: revenues, liabilities, and source of funds.
You can remember this using the PEARLS acronym, where the first three letters (purchases, expenses, and assets) are debited when increased, and the last three letters (revenues, liabilities, and source of funds) are credited when increased. The opposite happens when these accounts are decreased.
Get the guide to double entry bookkeeping
Enter your details to access our expert resource
As you can see above, when we increase purchases, expenses and assets accounts, they are debited.
When we decrease revenue, liability and source of funds accounts, they are also debited.
Let’s look at some examples:
Example 1: You buy new office furniture for £5,000. As you are gaining an asset, you increase the asset account, which means you are debiting it.
Example 2: Your sales team sells some software to a customer for £300. They forgot to apply an advertised discount of £50, meaning they will now need to decrease the revenue account by £50. As you are decreasing a revenue account, this is a debit.
Credits and debits apply in opposite situations. When we increase revenues, liabilities, and source of funds accounts, they are credited.
When we decrease purchases, expenses and assets accounts, they are also credited.
Let’s apply this to the examples above:
Example 1: You buy new office furniture for £5,000. This is a liability because you have to pay the furniture supplier £5,000. Therefore, the liabilities account is increased, and this is a credit.
Example 2: Your sales team sells some software to a customer for £300. They forgot to apply an advertised discount of £50, meaning they will now need to decrease the revenue account by £50. As well as decreasing the revenue account, you are also decreasing the assets account (because you are returning money you thought you owned), meaning the assets account needs to be credited.