Accounting 101 – Debit and Credit
Small Business Bookkeeping Basic Account Entry
Even though using bookkeeping software will help with the daily use of accounting functions for a small business, it’s still important to have an understanding of the basic functions of accounting. Just because a calculator can help someone add and subtract, doesn’t necessarily mean that they will understand addition and subtraction. Understanding how debits and credits work is the first step into grasping the fundamentals of bookkeeping.
Accounting 101 Basics- What are Debits and Credits?
Any monetary transactions that affect the assets or liabilities of a business are posted to journals with debits and credits. Before the invention of computers, journals were posted manually with hand-written entries. Posting to manual journals is the best learning tool for understanding the basic concept of a debit and credit.
When posting to a journal, the debit (DR) and credit (CR) oppose each other and the entries must equal or balance each other. In terms of how to distinguish the function of the two entries, it’s best to look at how the two entries affect cash. Debits increase cash where as credits decrease cash.
Debit and Credit Affects on Accounts
Debit Increases Credit Decreases
- Assets
- Expenses
- Dividends
Debit Decreases Credit Increases
- Liabilities
- Revenue (Sales)
- Equity
Posting Debits and Credits to the Sales Journal
Look at an illustration in terms of posting the sale of a product. Sale amount $100.00, product acquisition cost amount of $50.00 and a sales tax of 5% or $5.00.
Sales Journal
- Cash DR $105.00
- Sale CR $100.00
- Tax CR $ 5.00
- Cost of sale DR $50.00
- Inventory CR $50.00
In this illustration cash increased by $105.00, the sale was recorded and the tax liability increased by $5.00. The product inventory was decreased by $50.00 and the cost of sale was recorded. The cost-of-sale and inventory accounts are known as reciprocal accounts. With computer accounting software, posting to one reciprocal account automatically posts to the other account. Notice that the total debits and credits offset each other and balance.
Posting Debits and Credits to the Expense Journal
Look at an illustration of purchasing gasoline for the company vehicle using cash. The cost of the gasoline for the company vehicle is $50.00.
Expense Journal
- Vehicle expense DR $50.00
- Cash CR $50.00
This is a very simple entry. With this entry vehicle expense was increased by $50.00 while the amount of cash was decreased by $50.00
Accounting Journals and General Ledgers
At the end of each business day, the journals debits and credits are added up and transferred to the general ledger. In the above illustrations each item description would have its own general ledger. Taking into account the total journal postings from the above illustrations, the total general ledger account posted at the end of the day would be as follows.
General Ledgers
- Cash DR $55.00 (DR $105.00 CR $50.00)
- Sales CR $100.00
- Tax CR $5.00
- C.O.S. DR $50.00
- Inventory CR $50.00
- Vehicle expense DR $50.00
At the end of each month, the general ledger totals are transferred to the financial statements. These illustrations are very simplistic compared to the complexity of most small businesses. Many small businesses can have hundreds of general ledger accounts. With computerized bookkeeping software, many of these functions are automatically posted from the sales invoice to the journals and then to the general ledgers.
Accounting 101 - Debit and Credit
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Small Business Accounting - Journals and Ledgers
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