Debits and Credits - how do they work?

This is possibly the most common question. So let's explore a few things here. ere are two parts to mastering this.

1. Knowing the Accounting Equation perfectly. Including knowing the normal balances.

2. Being able to allocate an account to its element (ie A,L,OE,CI,D,R,E).

You need to master both of these.

1. Accounting Equation

A  =  L   +  OE

Dr = Cr      Cr

Do you have a Debit Card and a Credit Card. If so try this exercise to help you remember your debits and credits.

Put your debit card down on the left. Your Debit Card is an asset (money in the bank) so Asset is a Debit

The Credit Card goes on the right. Your credit card is a liability (money you owe) and so Liabilities are Credits.

Owners' Equity is on the same side as Liabilities and so it is a Credit Also.

Expand Accounting Equation to recognise Owners Equity Temporary Accounts.

You then need to remember that anything that increase OE is a Credit (conversely anything that reduces OE is a Debit)

OE(ob) + CI-D+R-E =OE(cb)

therefor CI and R are Cr

D and E are Debits

another way to remember these is DEAD

Drawings, Expenses, Assets are Debits

2. Allocation of an account to its element (A,L,OE,CI, D,R,E)

This is something that probably does take some practice. There are the easy items, but there are also some that are a bit harder. See the page on Accounting Elements

Once you have this base you are on a good position to understand the accounting equation perfectly. To do this you will need to add,

  • the relationship between the accounting equation and the financial statements
  • the order of the chart of accounts
  • permanent accounts and temporary accounts, so that you can do the closing entries