Debits Explained for Dummies

Including debit balances

 

What is a debit?

In accounting, debit refers to an entry in one of the appropriate general ledger accounts of a business or individual that either increases an asset, expense, and loss account or decreases a liability, revenue, or equity account. The opposite of a debit entry is a credit entry that either increases a liability, revenue, or equity account or decreases an asset or expense account. The term ‘debit’ derives from the Latin word ‘debere’, which means ‘to owe’ or ‘what is due.’ The double-entry system of bookkeeping or accounting uses T-accounts to record debits and credits. Debits are recorded on the left side of a T-account and a credit on the right side. Typically, a debit is abbreviated as ‘dr.’ and credit as ‘cr.’  

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A summary of the use of debits in accounting

As mentioned, debits affect different accounts in the double-entry accounting system in one way or another. The 5 major accounts that are affected by debits are asset accounts, expense accounts, liability accounts, revenue accounts, and equity accounts. In addition, accounts such as loss accounts, contra-revenue accounts, contra-liability accounts, and contra-equity accounts are increased by debit entries. Major accounts that are increased by debits

Asset accounts

An asset is a resource or item with economic value, providing a future economic benefit to a business or individual. A debit will, inter alia, increase the following asset accounts: cash, property, plant and equipment, inventory, prepaid expenses, vehicles, and accounts receivable.

Expense accounts

An expense refers to the cost incurred in the daily operations of a business in order to generate income (revenue). Examples of expense accounts that are increased by debit entries: salaries, rent, finance charges, advertising, travelling, and advertising.  

Other types of accounts that are increased by debits

Loss accounts

Loss accounts reflect losses, such as loss on the sale of assets or loss from a lawsuit. Losses recorded as debits in such an account increase the total amount of losses.

Contra-revenue accounts

Contra-revenue accounts such as ‘sales discounts’ and ‘sales returns’ are debited when returns or discounts on sales are allowed, increasing the balances of the accounts. Eventually, the credit balance of the revenue account of sales will be decreased by the debit balances in the contra-revenue accounts.

Contra-liability accounts

Contra-liability accounts refer to accounts like ‘discount on bonds payable’ or ‘unamortised bond issue costs.’

Contra-equity accounts

Contra-equity accounts include accounts such as the owner’s personal drawings account and the treasury shares account.

• Treasury shares account

Treasury shares, also referred to as treasury stock or reacquired stock, refer to previously outstanding shares which a company bought back from shareholders to deal with the shares as the company pleases. When outstanding shares are repurchased by a company, the treasury shares account is debited, increasing the total of the account. The account has a debit balance that reduces the total amount of shareholders’ equity. Hence, it is called a contra-equity account.

• Owner’s personal drawings account

When an owner draws money from his or her business or pays for personal stuff from a business account, the amount is debited to the personal drawings account, increasing the total of the account. Usually, drawings are recoverable from the owner by way of cash or in-kind return, such as goods or services instead of money, or adjustments to the owner’s equity account. A drawings account is considered an asset until it is recovered.  

Accounts that are decreased by debits

Liability account

Liability refers to a financial obligation or debt, resulting from previous financial transactions, that a business or individual owes to another party (for example, creditor or lender), causing future sacrifices of economic benefits (assets). Debit entries will decrease liabilities such as loans, accounts payable, mortgages, deferred revenues, tax payable, and accrued expenses.

Revenue account

Revenue accounts are accounts related to income received from the sale of goods and services. It also refers to interest earned from investments. Examples of revenue accounts that will be decreased when debit entries are recorded in the particular account are sales, service revenues, interest income, investment income, and fees earned.

Equity account

Owner’s equity is one of the three components of the accounting equation: Assets = Liabilities + Owner’s equity. Put differently, Owner’s equity = Assets - Liabilities. Owner’s equity comprises different equity accounts, reflecting the financial representation of the ownership of a business. Equity accounts have different resources and, therefore, are classified into different types of accounts.   Normally, equity accounts have credit balances. The treasury shares account is the exception with a debit balance. Equity accounts commonly used by companies and that is decreased by debits include:

• Ordinary shares account

Ordinary shares also referred to as common stock, are issued to ordinary shareholders and represent a portion of ownership in the issuing company.  

• Preference shares account

Preference shares, also called preferred stock, like ordinary shares allows a shareholder a slice of the ownership of a company and have certain preferential rights over ordinary shareholders.  

• Additional paid-in capital account

Additional paid-in capital, commonly referred to as share premium, refers to the amount received by a company in excess of the par value of its shares. However, regarding South African companies, subject to the Companies Act (Act 71 of 2008), a share premium is no longer allowed or applicable.  

• Retained earnings

Retained earnings (RE) are the accumulated profits of a business to date that are reserved for reinvestment back into the business and for the expansion of business operations. The amount reported on the balance sheet under shareholders’ equity is calculated as follows: RE balance at the beginning of the accounting period plus the net income or minus the net loss for the specific accounting period less the total amount of dividends distributed to shareholders.   The following debits, for example, will decrease the retained earnings: a loss or dividends issued.  

What is a debit balance?

In accounting, a debit balance indicates that the total amount of debit entries in a general ledger account exceeds the total amount of the credit entries in the particular account. Put differently, a debit balance occurs when the total on the left side of the general ledger account is more than the total on the right side of the account. The following accounts have normal debit balances, meaning that is expected that the specific account will have a debit balance: assets, expenses, losses, contra-revenue accounts, contra-liability accounts, and contra-equity accounts.

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