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"Debiting" or "Crediting" an account is just a simple accounting term. Think of it like we're "pushing a button" (metaphorically speaking) on an account in our system to either increase or decrease it. All we're trying to do is record what happened in a transaction within our accounts, so we can keep track of everything. That's it!
FALSE. A debit can sometimes decrease an account. It depends on which type of account you're debiting!
FALSE. A credit can sometimes increase an account. It all depends on which type of account you're debiting!
Students think this sometimes, but it's not necessarily true. Debits and Credits are very simple. They're just a way for us to either INCREASE or DECREASE an account, to record what happened in a transaction. How we increase or decrease an account depends on the type of account! (Asset, Liability, Equity, Revenue, or Expense)
FALSE! This is a very common misunderstanding! While these terms share names with common banking tools, their usage in accounting is completely different.
Assets (+/-), Liabilities (-/+), Equity (-/+), Revenues (-/+), Expenses (+/-).
(+/-) Debit increases, Credit decreases.
(-/+) Debit decreases, Credit increases.
(-/+) Debit decreases, Credit increases.
(-/+) Debit decreases, Credit increases.
(+/-) Debit increases, Credit decreases.
(+/-) Debit increases, Credit decreases (contra Equity, so "opposite of" equity).
They decrease Equity (Retained Earnings).
(-/+) Debit decreases, Credit increases (contra Asset, so "opposite of" assets).
Reflects asset value reduction over time.
- Assets works like (+/-)
- L + E both work like (-/+)
Therefore, remember that Assets always behave oppositely to Liabilities and Equity. Since Assets work on a (+/-) basis, then Liabilities and Equity will be (-/+).
- This flip across the equal sign of A = L + E is a great visual memory aid!
Assets = Liabilities + Equity Revenues / Expenses (+/-) (-/+) (-/+) (-/+) (+/-)
- Revenues and Equity, both operating on a (-/+) basis, share a logical connection.
- Generating revenue increases a company's value, which is reflected in its equity.
- Therefore, if increasing revenue boosts equity, it makes sense that they both function similarly, utilizing a (-/+) mechanism.
- To summarize, memorize this: revenue (-/+) and equity (-/+) always work the same when it comes to debits and credits!
Assets = Liabilities + Equity Revenues / Expenses (+/-) (-/+) (-/+) (-/+) (+/-)
- There’s a reason that expenses and equity work opposite of eachother.
- Expenses are our “costs.” Doesn’t it make sense that costs reduce a company's equity, or “value”?
- Therefore, since incurring expenses decreases equity, it's logical that they operate inversely — Expenses being (+/-) and Equity being (-/+).
- Remember this key point: expenses (+/-) and equity (-/+) work oppositely when it comes to debits and credits.
- Expenses and Assets, both following a (+/-) pattern, are intrinsically linked.
- For instance, expenses will often orginate from our assets —particularly when these assets are consumed or utilized.
- Let's consider some examples to illustrate this relationship:
- A building (an asset) depreciates over time, turning into a depreciation expense.
- Inventory (an asset) transforms into the Cost of Goods Sold (an expense) once sold.
- Prepaid Rent (an asset) turns into Rent Expense as the lease term elapses.
- Prepaid Insurance (an asset) becomes Insurance Expense as our coverage expires.
- Accounts Receivable (an asset) morphs into Bad Debt Expense when a customer defaults on payment.
- Many other examples exist!
- Assets can be thought of as 'pending' expenses that will be utilized or 'expensed' eventually.
- Conversely, sometimes, expenses can best be viewed as assets that have been consumed. This cyclical relationship suggests that they're essentially the same thing at different stages.
- Given this, it logically follows that assets and expenses operate identically regarding debits and credits, adhering to the (+/-) pattern.
- To summarize, memorize this: Assets (+/-) and Expenses (+/-) always work the same when it comes to debits and credits!
- This is not true! Whether a debit or credit increases or decreases an account depends on the type of account.
- Again, this is false! Debits and credits are used to record all types of transactions, not just receiving or giving things away.
- This is a very common misunderstanding! While these terms share names with common banking tools, their usage in accounting is completely different.
These misconceptions can seriously hinder your understanding of accounting. Unlearn them now!
Know the account type: A = L + E, Revenue/Expense, or Contra Account.
Since Common Stock is an EQUITY account, it works like (-/+). Therefore, Common Stock increases with a CREDIT.
Since Cash is an ASSET (something we own), it works like (+/-).
Since Wages Payable is a LIABILITY (all Payables are liabilities), it works like (-/+). Therefore, Wages Payable decreases with a DEBIT.
Since Retained Earnings is an EQUITY account, it works like (-/+). Therefore, Retained Earnings increases with a CREDIT.
Dividends is a Contra Equity account, so it works OPPOSITE of Equity. Equity works like (-/+), therefore Dividends work like (+/-). So, Dividends increases with a DEBIT!
Since Cost of Goods Sold is an EXPENSE account, it works like (+/-). Therefore, Cost of Goods Sold increases with a DEBIT.
Since Accounts Receivable is an ASSET account (all receivables are assets), it works like (+/-). Therefore, Accounts Receivable decreases with a CREDIT.
Since Fees Earned is an REVENUE account (remember, anything "EARNED" is revenue), it works like (-/+). Therefore, Fees Earned increases with a CREDIT.
Since Unearned Revenue is a LIABILITY, it works like (-/+). Therefore, Unearned Revenue decreases with a DEBIT.
Accumulated Depreciation is a Contra Asset account, so it works OPPOSITE of Assets. Assets work like (+/-), therefore Accumulated Depreciation works like (-/+).
Pay cash? The journal entry MUST ALWAYS include a credit to cash. Receive cash? The journal entry MUST ALWAYS include a debit to cash. It's that simple. You can always rely on this "cheat code" to help you!
TRUE. Cash is an asset (+/-). Therefore, anytime you PAY cash, you must to credit Cash to reduce it.
TRUE. Cash is an asset (+/-). Therefore, anytime you RECEIVE cash, you must to debit Cash to increase it.
A normal balance is the side (debit or credit) that increases the value of a specific type of account. It's considered the "expected" balance of an account.
To determine the normal balance of an account, simply choose the side (debit or credit) that increases it! (Example: Cash increases with a Debit, so it has a normal balance of Debit.)
CREDIT. R/E is an Equity account (-/+), so the normal balance is CREDIT.
DEBIT. Dividends is a Contra Equity account (+/-), so the normal balance is DEBIT.
CREDIT. Accumulated Depreciation is a Contra Asset account (+/-), so the normal balance is CREDIT.
CREDIT. Interest Earned is an Revenue account (-/+), so the normal balance is CREDIT.
DEBIT. A/R is an Asset account (+/-), so the normal balance is DEBIT.
CREDIT! Wages Payable is a Liability account (-/+), so the normal balance is CREDIT.
CREDIT! Unearned Revenue is a Liability account (-/+), so the normal balance is CREDIT.
DEBIT! Depreciation is an Expense account (+/-), so the normal balance is DEBIT.
DEBIT! COGS is an Expense account (+/-), so the normal balance is DEBIT.
DEBIT! Cash is an Asset account (+/-), so the normal balance is DEBIT.
DEBIT! Anything "Prepaid" is an Asset account (+/-), so the normal balance is DEBIT.
CREDIT! Common Stock is an Equity account (-/+), so the normal balance is CREDIT.
DEBIT! Notes Receivable is an Asset account (+/-), so the normal balance is DEBIT. (Remember, ALL "receivables" are assets!)
DEBIT! Building is an Asset account (+/-), so the normal balance is DEBIT.
To determine the normal balance of an account, simply choose the side (debit or credit) that increases it!
Anything “receivable” (e.g. accounts receivable, notes receivable, interest receivable) or “prepaid” (e.g. prepaid insurance, prepaid rent, prepaid supplies) is always categorized an asset.
Because we OWN something. Think about it... they represent the right to collect cash in the future—and cash is an asset! This makes receivables an asset as well.
Anything “payable” (e.g. accounts payable, notes payable, interest payable, etc.) or “unearned” (e.g. unearned rent revenue, etc.) is always a liability.
Anything “earned” (e.g. fees earned, rent earned, interest earned, etc) is always a revenue account. (However, don't get caught out — despite its name, Retained Earnings is an equity account, not a revenue account!)
Anything “expense” (e.g. rent expense, wages expense, depreciation expense, etc) is always an expense account. Duh! (However, be careful. Cost of Goods Sold is also an expense account, despite not having “expense” in the account title!)
Phrases like performed, delivered, rendered, or completed services are clear signs of earned revenue from services. Also, Phrases like sold, delivered, or shipped goods always indicates earned revenue from selling inventory.
Phrases like on credit or on account suggest that cash payment or receipt is deferred to later, often involving accounts receivable or payable.
Phrases such as received cash in advance or received cash upfront typically signify Unearned Revenue transactions, where we’ve received cash in advance for services to be provided later.
It means acquiring assets now and committing to pay for them later, typically within terms like 30, 60, or 90+ days. In essence, you receive the asset first, and then settle the payment at the agreed-upon later date.
Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the insurance expense for the portion used during the year, a concept we’ll delve into in chapter 3. Insurance Expense 6,000 Prepaid Insurance 6,000
The $6,000 Insurance Expense that was debited is calculated as follows:
- The $12,000 paid for the 12-month policy works out to a monthly cost of $1,000.
- From July 1st to December 31st, a total of six months have elapsed.
- Six months at $1,000 per month gives us an Insurance Expense of $6,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $6,000 Prepaid Insurance that was credited is calculated as follows:
- On July 1st, we debited Prepaid Insurance for $12,000.
- By December 31st, six months of the policy have been utilized, leaving only half of the initial policy value intact.
- If we don't reduce the Prepaid Insurance account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid insurance.
- Consequently, we must credit Prepaid Insurance, an asset account, to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the rent expense for the portion used during the year, a concept we’ll delve into in chapter 3.
Rent Expense 8,000 Prepaid Rent 8,000
The $8,000 Rent Expense that was debited is calculated as follows:
- The $24,000 paid for the 12-month lease works out to a monthly cost of $2,000.
- 24,000 / 12 months = 2,000 per month
- From August 31st to December 31st, a total of four months have elapsed.
- Four months at $2,000 per month gives us an Rent Expense of $8,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $8,000 Prepaid Rent that was credited is calculated as follows:
- On August 31st, we debited Prepaid Insurance for $24,000.
- By December 31st, four months (4/12) of the lease have been used, leaving eight months (8/12) of the lease remaining.
- If we don't reduce the Prepaid Rent account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid rent.
- Consequently, we must credit Prepaid Rent, an asset account, to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
Adjusting Entry on Dec 31: On December 31st, an adjusting entry is required to recognize the advertising expense for the amount used during the year, concept we’ll discuss in Chapter 3. Advertising Expense 60,000 Prepaid Advertising 60,000
The $60,000 Advertising Expense that was debited is calculated as follows:
- The $180,000 paid for the 36-month advertising contract works out to a monthly cost of $5,000.
- 180,000 / 36 months = 5,000 per month
- From January 1st to December 31st, a total of twelve months have elapsed.
- Twelve months at $5,000 per month gives us an Advertising Expense of $60,000.
- We debited the expense to increase it, which is how we recognize an expense — since all expense accounts work like (+/-).
The $60,000 Prepaid Advertising that was credited is calculated as follows:
- On January 1st, we debited Prepaid Advertising for $180,000.
- By December 31st, twelve months out of thirty six (12/36) of the contract have been used, leaving 24 months (24/36) remaining.
- If we don't reduce the Prepaid Advertising account by crediting it, our balance sheet would inaccurately represent an overstated value for our prepaid advertising.
- Consequently, we must credit Prepaid Advertising, an asset account (+/-), to decrease it to the correct remaining amount.
- Refer to the T Account below for reference.
"Prepaid" accounts are used when benefits from a payment extend beyond the current period. They're assets until consumed, then gradually expensed, aligning with the matching principle.
Adjusting Entry on Dec 31: On December 31st, 2023, an adjusting entry is required to recognize the unearned revenue that was “earned” during the year, a concept we’ll delve into in chapter 3.
Unearned Revenue 40,000 Fees Earned 40,000
Here's how we get the $40,000:
- The total contract value of $240,000 is split evenly over the course of 12 months, leading to an 'earned' revenue of $20,000 per month.
- (240,000 / 12 = 20,000)
- By the end of December, two months of service have been delivered, thereby earning $40,000 in revenue (2 months x $20,000 per month).
- This earned amount of $40,000 is then debited from Unearned Revenue, a liability account (-/+), and credited to Fees Earned, a revenue account (-/+), reflecting a decrease in the liability and an increase in revenue.
This adjustment ensures that the financial statements of the company accurately represent its financial position and earnings performance. It adheres to the revenue recognition principle which mandates that revenues must be recognized in the accounting period in which the services were actually delivered.
- On December 31st, we debited Unearned Revenue, a liability account (-/+), in order to decrease it.
- This accurately shows that we now owe $40,000 less for the consulting contract as we've already provided two out of twelve months of contract.
- To view it differently: If we failed to debit (i.e. decrease) Unearned Revenue, our balance sheet would falsely represent a higher liability. It would seem as though we owe more services than we actually do.
- To illustrate, imagine the company forgot to record this adjusting entry. Consequently, our balance sheet on 12/31 would incorrectly show $240,000 in services owed, whereas the actual figure should be $200,000!
- Therefore, it's essential to debit Unearned Revenue to adjust it to the accurate remaining value of services we're obligated to deliver.
- Refer to the T Account below for reference.
- On December 31st, we credited Fees Earned, a revenue account (-/+), in order to increase it.
- This accurately captures that we've earned $40,000 from the consulting contract, having delivered two out of twelve months of service.
- To view it differently: If we didn't credit (increase) Fees Earned, our income statement would not fully represent our earnings.
- For instance, if we neglected to record this adjusting entry, our income statement on 12/31 would fall short by $40,000 in revenue.
- Therefore, it's crucial to credit Fees Earned to record the accurate amount of revenue we've generated from services performed.
- This adjusting entry also ensures adherence to the revenue recognition principle. It states that revenues must be captured as they're earned, and in the same period they occur. In other words, failing to record this adjusting entry on 12/31, the final day of the year, would mean missing out on reporting this revenue in the correct year!
Cash received for services/products not yet provided.
It represents owed services/products for which we've already been paid for.
Customers get goods/services now and pay later, often within 30, 60, or 90+ days. Essentially, you provide the service, send an invoice, and await payment.
Accounts Receivable represents money we expect to receive later fromp customers, while Accounts Payable is money the business owes to suppliers. Essentially, Receivable = money coming in later; Payable = money going out later.
📌 Accounts Receivable and Accounts Payable are often confused by students. Check out this brief comparison below to help you avoid common mistakes on exams.
DEBIT
CREDIT
Accounts Receivable or Accounts Payable
Debit Prepaid Asset, Credit Cash
Debit Cash, Credit Unearned Revenue
Revenue should be recorded when earned, not when cash is received
CREDIT! Revenue accounts work like (-/+). When we earn revenue, we need to increase the revenue account.
When we provide services on credit, the customer pays later, but the revenue is recognized as soon as the services are delivered, as per the revenue recognition principle.
If we receive cash in advance for services we will provide later, this is recorded as Unearned Revenue — a prime example that receiving cash doesn’t always equate to generating revenue!
Of course! However, it's vital to understand that revenue is attributed to the services rendered, not the cash received. The cash received does not trigger the revenue; it is the completion of the services that does.
Recognize expenses when costs are incurred, not necessarily when cash is paid.
DEBIT! Expense accounts work like (+/-). When we incur costs, we need to increase the expense account.
One example that illustrates this well is depreciation expense. Depreciation refers to the gradual decrease in value over time of long-term assets such as buildings and equipment. Depreciation is a cost that simply “occurs” as time passes, completely independent of any cash payment
Suppose a company has incurred employee salaries and wages for the current month but hasn't yet paid them. Even without a cash outflow, the company recognizes the expense by accruing the salaries and wages payable, a topic we’ll elaborate further in Chapter 3.
If we purchase supplies by paying cash, we're essentially trading one asset (cash) for another (supplies). At this point, no expense is recognized. Why not? Because we haven't used these supplies yet.
Paying cash for a building (an asset) is NOT an expense. However, as it depreciates over time, we will recognize depreciation expense later!
Paying cash for inventory (an asset) is NOT an expense. However, we will record Cost of Goods Sold (an expense) once it’s sold later!
Paying cash for Prepaid Rent (an asset) is NOT an expense. However, we will record Rent Expense later as the lease term elapses.
Paying cash for Prepaid Insurance (an asset) is NOT an expense. However, we will record Insurance Expense later as our coverage expires or is used.
Yes, of course! For example, when paying for utilities consumed, we debit Utilities Expense and credit Cash. However, the expense arises from the cost incurred (utilities used) rather than the act of paying cash.
Journal Entries > Posting > Unadjusted Trial Balance > Adjusting Entries > Adjusted Trial Balance > Financial Statements > Closing Entries > Post Closing Trial Balance
Income Statement, Statement of Retained Earnings, Balance Sheet
1. Income Statement 2. Statement of Retained Earnings 3. Balance Sheet
Revenues and Expenses only
Assets, Liabilities, and Equity only
Total Revenues - Total Expenses = Net Income or Net Loss
Expenses > Revenues
Revenues > Expenses
Beginning R/E + Net Income (or - Net Loss) - Dividends = Ending R/E
Net Income or Loss from Income Statement is needed
Net Income increases, Net Loss and Dividends decrease Retained Earnings
Dividends reduce Retained Earnings
Net Income increases Retained Earnings
Zero
No formula; just list out all Assets, Liabilities, and Equity and ensure Total A = Total L + E
Balance Sheet
Requires ending balances from other statements
Balance Sheet
It captures ending balances at a specific date
Income Statement and Statement of Retained Earnings
They report revenues and expenses occuring over a period
FALSE
FALSE
TEMPORARY Accounts
PERMANENT Accounts
They reset to zero each period via Closing Entries
They carry forward balances year to year. For instance, $100,000 cash at year-end becomes the starting balance for the next year.
All we're trying to do is record what happened in a transaction within our accounts. "Debiting" or "Crediting" an account is really just an accounting term. Think of it like we're "pushing a button" (metaphorically speaking) on an account in our system to either increase or decrease it. That's it!
Assets (+/-), Liabilities (-/+), Equity (-/+), Revenues (-/+), Expenses (+/-).
Know the account type: A = L + E, Revenue/Expense, or Contra Account.