In accounting, debits and credits are used to record the effects of transactions on a business’s financial records. Debits are used to record increases in assets, //businesshubs.org/ and decreases in equity. Credits are used to record increases in liabilities, increases in equity, and decreases in assets.
A business uses a credit to record the following types of transactions:
- Increases in liabilities: When a business borrows money from a lender, it increases its liability to the lender. This increase is recorded as a credit to the liability account.
- Increases in equity: When a business earns revenue, it increases its equity. This increase is recorded as a credit to the revenue account.
- Decreases in assets: When a business pays a liability, it decreases its asset account. This decrease is recorded as a credit to the liability account.
- Decreases in expenses: When a business incurs an expense, it decreases its equity. This decrease is recorded as a credit to the expense account.
It is important to note that the use of debits and credits is not arbitrary. There are specific rules that govern how debits and credits are used to record transactions. These rules are known as the accounting equation.
The accounting equation states that the total of all assets must equal the total of all liabilities and equity. This equation can be used to help ensure that debits and credits are used correctly when recording transactions.
By understanding how debits and credits are used, businesses can accurately record their financial transactions and prepare accurate financial statements.
Here are some additional examples of how a business might use a credit to record a transaction:
- A business receives payment from a customer for goods or services sold. The business credits accounts receivable and debits cash.
- A business pays its rent for the month. The business debits rent expense and credits accounts payable.
- A business declares and pays a dividend to its shareholders. The business debits dividends and credits retained earnings.
By understanding the rules of debits and credits, businesses can accurately record their financial transactions and prepare accurate financial statements.
