Accounting Equation
Recall the fundamental accounting balance sheet equation: Assets = Liabilities + Shareholders Equity
The left side of the equation is assets.
The right side of the equation is liabilities and shareholders equity.
Remember this part. It is important to understand debits and credits.
Debit and Credit Explained
A debit is when:
-increase in the left side of the equation
-decrease in the right side of the equation
A credit is when:
-decrease in the left side of the equation
-increase in the right side of the equation
So the opposite of a debit is a credit.
General rule to remember: a debit is an increase on the left side. Therefore an increase to an asset, such as an increase in cash, is a debit. It increases the left side of the equation. A decrease in an asset such as cash has the opposite effect and is called a credit. It decreases the left side of the equation.
What about for liabilities and shareholders equity? It’s just the reverse of the general rule above. Therefore an increase to a liability, such as an increase in debt, is a credit. It increases the right side of the equation. An decrease in a liability such as debt has the opposite effect and is called a debit. It decreases the right side of the equation.
Debit and Credit Examples
Let’s walk through some examples.
Increase in cash This is a debit since it increases the left side of the equation. Cash is an asset, so an increase in cash results in greater assets which means an increase on the left side of the fundamental accounting equation.
Decrease in cash This is a credit since it decreases the left side of the equation. Cash is an asset, so a decrease in cash results in lower assets which means an decrease on the left side of the fundamental accounting equation.
Increase in accounts receivable Accounts receivable is an asset since it is a balance of how much you are owed. So therefore an increase to an asset is a debit.
Decrease in plants, property, and equipment (PPE) PPE is an asset since it is a balance of how much you are owed. So therefore a decrease to an asset is a credit.
Increase in taxes payable Taxes payable is a liability since it represents how much you owe in taxes. So therefore an increase to a liability is a credit.
How to categorize accounts in accounting? Is an account an asset, liability, or something else? What is an accounting asset? What is an accounting liability? What goes in shareholders equity?
Definition: An asset is a future economic increase. It results in cash or a gain in the future. A liability is a future economic decrease. It results in a decrease in cash or a loss in the future.
Common Accounts in Accounting Cash Accounts Receivable Accrued Revenue Deferred Expenses Machinary and Equipment Plant, Property, and Equipment
Accounts Payable Accrued Expenses Unearned Revenue Wages Payable Taxes Payable
Deferred Expenses, Accrued Expenses, Accrued Revenue, Unearned Revenue This is a topic that confuses some people starting out in accounting. I’ll try to explain it as simply as possible.
