About Transaction Analysis of Debits and Credits

The basic accounting equation can be summarized as follows:

Assets = Liabilities + Owner's Equity

Positive asset balances are called debits and positive liability owner's equity balances are called credits. Thus, the left side of the accounting equation is called the debit side, and the right side is called the credit side.

When viewed in terms of debit and credit sides, the accounting equation looks like this:

Assets

Liabilities + Owner's Equity

Debit Side
(Positive asset account balances)

Credit Side
(Positive liability and owner's equity account balances)


To maintain the accounting equation, positive debit balances must always equal positive credit balances; that is, debits must always equal credits. Before recording every transaction, a business must determine the transaction's effects on accounts in terms of debits and credits. This process is called transaction analysis. After each transaction is analyzed, total debits made to accounts must equal total credits made to accounts. This rule is the basis of the double-entry accounting system (see About Double Entry Accounting). It means that for every dollar entered as a debit to one account, a dollar must be entered as a credit to some other account.

One way to illustrate how debits and credits are used to record increases and decreases to accounts is the T account. The T account, which is illustrated below, has the appearance of the letter T.

Account Name

Debit

Credit


The left side of the T account is always the debit side and the right side is always the credit side. The title of the account always appears at the top of the T.

An amount entered on the left side of an account is called a debit entry, or simply a debit, and an amount entered on the right side of an account is called a credit entry, or a credit. The process of entering a debit into an account is referred to as debiting an account, and the process of entering a credit is referred to as crediting an account. (The term charge is a synonym for the term debit; thus to charge an account is to debit an account.)

Asset and liability accounts may each have credits and debits. However, the definition of what constitutes a debit versus a credit differs between the two types of accounts.

  • Assets: because assets in the accounting equation appear on the debit side of the basic accounting equation, positive amounts are recorded on the debit side and negative amounts are recorded on the credit side of the asset account.
  • Liabilities: because liabilities and owner's equity in the accounting equation appear on the credit side of the basic accounting equation, positive amounts are recorded on the credit side and negative amounts are recorded on the debit side of the liability and the owner's equity accounts.

The difference between total debits and total credits is called the account balance. If the total debits exceed the total credits, the difference is called a debit balance; if the total credits exceed the total debits, the difference is called a credit balance. A normal balance for any account is a positive balance. Hence a normal balance for an asset account is a debit balance, and normal balance for a liability or owner's equity account is a credit balance.

Example:

To illustrate an account, assume the Demo Association began business on January 1. The following credit sales are made during the month of January: January 2, $2,000; January 6, $500; January 14, $1,500; and January 25, $3,000. The following collections on accounts receivable were also made during the month of January: January 10, $500; January 21, $2,000; and January 24, $1,500.

The increases in accounts receivable that occurred when the credit sales were made are shown on the debit (left) side of the account and the decreases in the accounts receivable that occurred when collections were made are shown on the credit (right) side as illustrated below.

Accounts Receivable

(Debit)

Jan. 2 $2,000

(Credit)

Jan. 10 $500

Jan. 6 $500

Jan. 21 $2,000

Jan. 14 $1,500

Jan. 24 $1,500

Jan. 25 $3,000

 

$7,000

$4,000

$3000

 


The increases are summarized by the $7,000 figure at the bottom of the Debit column. Decreases are summarized by the $4,000 at the bottom of the Credit column. These summaries are also called footings.

Based on the debits and credits recorded for this account, by January 31 the balance of the account is $3,000 (shown as the figure at the bottom left of the debit account). Since accounts receivable is an asset account, the $3,000 debits balance is also the normal balance. If there had been a credit balance, it would have been written in small figures to the left of the total for the credit column.

When the balance of the account is obvious, it is not necessary to foot the T account.

As we indicated earlier, the effect of revenue is to increase owner's equity, and the effect of an expense or a withdrawal is to decrease owner's equity. Because an owner's equity account is increased by credits and decreased by debits, it follows that a revenue account is increased by credits (has a normal credit balance) and decreased by debits. Conversely, expense accounts and withdrawals accounts are increased by debits (have normal debit balances) and decreased by credits.

The principles for debiting and crediting asset, liability, owner's capital, revenue, expense, and withdrawals accounts can be summarized as follows:

Debit

Credit

Increase assets*
Decrease liabilities
Decrease owner's capital
Decrease revenue
Increase expense*
Increase withdrawals*

Decrease assets
Increase liabilities*
Increase owner's capital*
Increase revenue*
Decrease expense
Decrease withdrawals


*Normal balance for this type of account

Remember that a normal (positive) balance in an asset, expense, or withdrawals account will be a debit balance, and a normal (positive) balance in a liability, owner's capital, or revenue account will be a credit balance.

Illustration of Transaction Analysis

To illustrate how transactions are analysed to determine their debit and credit effects, we will analyse several transactions that take place during the month of May for an organization.
Transaction 1: On May 5 the National Headquarters sells 50 T-Shirts, generating Sales Order # 1. The purchase price for the shirts is $2.00 each; however, the cost of each shirt is $0.70.

Accounts Receivable

Product Sales

(Debit)

May 5 $100

(Credit)

May 5 $100

 

Cost of Goods Sold

Tee Shirt Inventory

(Debit)

May 5 $35

(Credit)

May 5 $35


Transaction 2: On May 7, using the Aptify Order Entry system, the National Headquarters organization sells an annual membership to the DC Chapter of the National Knitting Club for $1,200.00 on credit.

Accounts Receivable

Deferred Revenues

(Debit)

May 5 $100
May 7 $1,200

(Credit)

May 7 $1,200


Transaction 3: On May 10, using the Aptify Scheduled Transaction Groups service, the National Headquarters organization expands the Scheduled Transaction Group related to the sale of the annual membership to the DC Chapter of the National Knitting Club for $1,200.00.

Deferred Revenues

Membership Revenues

(Debit)

5/07/06 $100.00
6/01/06 $100.00
07/01/06 $100.00
08/01/06 $100.00
09/010/06 $100.00
10/01/06 $100.00
11/01/06 $100.00
12/01/06 $100.00
01/02/07 $100.00
02/02/07 $100.00
03/02/07 $100.00
04/02/07 $100.00
05/02/07 $100.00

(Credit)

05/10/06 $1,200.00

(Credit)

05/07/06 $100.00
06/01/06 $100.00
07/01/06 $100.00
08/01/06 $100.00
09/01/06 $100.00
10/01/06 $100.00
11/01/06 $100.00
12/01/06 $100.00
01/01/07 $100.00
02/01/07 $100.00
03/01/07 $100.00
04/01/07 $100.00
05/01/07 $100.00


Transaction 3: On May 15, using the Aptify Payments service, the National Headquarters organization processes the $100 Cash Receipt transaction related to Sales Order # 1.

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