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In this article, you will learn the rules of debit and credit; when and how to

use them.
Account
First, let us recall the definition of an "account". An account is a storage unit
that stores similar items or transactions.
Examples of accounts are: Cash, Accounts Receivable, Office Equipment,
Accounts Payable, Service Income, Rent Expense, and so on.
Let's take Cash, for instance. The Cash account stores all transactions that
involve cash, i.e. cash receipts and cash disbursements.
Debit and Credit
Second, let us define "debit" and "credit". Debit means left and credit means
right. Do not associate any of them with plus or minus yet. Debit simply
means left and credit means right that's just it! "Debit" is abbreviated as
"Dr." and "credit", "Cr.".
The terms originated from the Latin terms "debere" or "debitum" which
means "what is due", and "credere" or "creditum" which means "something
entrusted or loaned".
Normal Balance
And third, we define what we call "normal balance". Each account has a debit
and a credit side. You could picture that as a big letter T, hence the term "T-
account". Again, debit is on the left side and credit on the right. Normal
balance is the side where the balance of the account is normally found.
Asset accounts normally have debit balances, while liabilities and capital
normally have credit balances. Income has a normal credit balance since it
increases capital . On the other hand, expenses and withdrawals decrease
capital, hence they normally have debit balances.
Now what is the significance of the "normal balance"?
When you place an amount on the normal balance side, you are increasing
the account. If you put an amount on the opposite side, you are decreasing
that account. Therefore, to increase an asset, you debit it. To decrease an
asset, you credit it. To increase liability and capital accounts, credit. To
decrease them, debit.
Example
Let us take Cash. Cash is an asset account. Again, asset accounts normally
have debit balances. Therefore, to increase Cash you debit it. To decrease
Cash, you credit it.
Another example let's take Accounts Payable. It is a liability account.
Liability accounts normally have credit balances. Thus, if you want to
increase Accounts Payable, you credit it. If you want to decrease Accounts
Payable, you debit it.
The same rules apply to all asset, liability, and capital accounts.
To Sum It Up
Here's a table summarizing the normal balances of the accounting elements,
and the actions to increase or decrease them. Notice that the normal balance
is the same as the action to increase the account.
Accounting Element Normal Balance To Increase To Decrease

1. Assets Debit Debit Credit

2. Liabilities Credit Credit Debit

3. Capital Credit Credit Debit

4. Withdrawal Debit Debit Credit

5. Income Credit Credit Debit

6. Expense Debit Debit Credit

Tip: You don't need to memorize the whole table. Just be familiar with the
normal balance portion and you'll be okay. The normal balance is the same
as the action to increase the account. The action to decrease the account is
simply the opposite of that.
Done? Now try these:
1. To increase Office Equipment, debit or credit?
2. To increase Rent Payable.
3. To record/increase Rent Expense.
4. To decrease Accounts Payable.
5. To record/increase Service Revenue.
6. To decrease Cash.
7. To record/increase Loss from Fire.
8. To decrease Delivery Equipment.
9. To increase Accumulated Depreciation
Answers:
1. Debit; 2. Credit; 3. Debit; 4. Debit; 5. Credit; 6. Credit; 7. Debit; 8. Credit.
What about item #9? How do you increase Accumulated Depreciation?
Accumulated Depreciation is a contra-asset account (deducted from an asset
account). For contra-asset accounts, the rule is simply the opposite of the
rule for assets. Therefore, to increase Accumulated Depreciation, you credit
it.
We will apply these rules and practice some more when we get to the actual
recording process.

After journal entries are made, the next step in the accounting cycle is
to postthe journal entries into the ledger.
Posting refers to the process of transferring entries in the journal into the
accounts in the ledger. Posting to the ledger is the classifying phase of
accounting.
An accounting ledger refers to a book that consists of all accounts used by the
company, the debits and credits under each account, and the resulting
balances.
While the journal is referred to as Books of Original Entry, the ledger is known
as Books of Final Entry.
Example: Posting Process
Let us illustrate how accounting ledgers and the posting process work using
the transactions we had in the previous lesson. Click here to see the journal
entries we will be using.
Let's start. Take transaction #1 first.
Date
2016
Particulars Debit Credit

Dec 1 Cash 10,000.00


Mr. Gray, Capital 10,000.00
Now, go to the ledger and find the accounts. Post the amounts debited and
credited to the appropriate side. Debits go to the left and credits to the right.
After posting the amounts, the cash and capital account would look like:
Cash Mr. Gray, Capital
10,000.00 10,000.00

Explanation: First, we posted the entry to Cash. Cash in the journal entry was
debited so we placed the amount on the debit side (left side) of the account
in the ledger. For Mr. Gray, Capital, it was credited so the amount is placed on
the credit side (right side) of the account. And that's it. Posting is simply
transferring the amounts from the journal to the respective accounts in the
ledger.
Note: The ledger accounts (or T-accounts) can also have fields for account number,
description or particulars, and posting reference.
Let's try to post the second transaction.
5 Taxes and Licenses 370.00
Cash 370.00
After posting the above entry, the affected accounts in the ledger would look
like these:
Cash Taxes and Licenses
10,000.00 370.00 370.00
There was a debit to Taxes and Licenses so we posted that in the left side
(debit side) of the account. Cash was credited so we posted that on the right
side of the account.
Notice that after posting transaction #2, we now can get a more updated
balance for each account. Cash now has a balance of $9,630 ($10,000 debit
and 370 credit). Nice, right? Post all the other entries and we will be able to
get the balances of all the accounts.
General Ledger Example
A general ledger contains accounts that are broad in nature such as Cash,
Accounts Receivable, Supplies, and so on. There is another type of ledge
which we call subsidiary ledger. It consists of accounts within accounts (i.e.,
specific accounts that make up a broad account).
For example, Accounts Receivable may be made up of subsidiary accounts
such as Accounts Receivable Customer A, Accounts Receivable Customer
B, Accounts Receivable Customer C, etc.
Okay let's go back to the general ledger. In the above discussion, we
posted transactions #1 and #2 into the ledger. If we post all 15 transactions
(click here to see the entries) and get the balances of each account at the
end of the month, the ledger would look like this:
ASSETS LIABILITES CAPITAL

Cash Accounts Payable Mr. Gray, Capital


10,000.00 370.00 500.00 8,000.00 10,000.00
1,900.00 3,000.00 1,500.00 3,200.00
3,200.00 8,000.00 9,000.00 13,200.00
4,250.00 500.00
12,000.00 7,000.00 Loans Payable Mr. Gray, Drawing
1,500.00 12,000.00 7,000.00
3,500.00
7,480.00
Service Revenue
Accounts Receivable 1,900.00
4,250.00 4,250.00 4,250.00
3,400.00 3,400.00
3,400.00 9,550.00

Service Supplies Rent Expense


1,500.00 1,500.00

Furniture and Fixtures Salaries Expense


3,000.00 3,500.00

Service Equipment Taxes and Licenses


16,000.00 370.00

After all accounts are posted, we can now derive the balances of each
account. So how much Cash do we have at the end of the month? As shown
in the ledger above, the company has $7,480 at the end of December.
How about accounts receivable? Accounts payable? You can find them all in
the ledger.
Note: The above is a simplified and theoretical example of a ledger. In reality,
companies have a lot more than 15 transactions! They may have hundreds
or even thousands of transactions in one day. Imagine how lengthy the
ledger would be. Worse, imagine the work needed in posting that many
transactions manually.
Because of technological advancements however, most accounting systems
today perform automated posting process. Nonetheless, the above example
shows how a ledger works.

Revenues (or income) refer to economic benefits received from business


activities.
Revenues are "increases in economic benefits during the accounting period
in the form of increases in assets or decreases in liabilities that result in
increases in equity, other than those relating to contributions from equity
participants".
The following points can be drawn from the definition of revenue:
1. Increase in benefits during the accounting period - Income is measured from
period to period, and provides economic benefits to the company.
2. Increase in assets or decrease in liabilities - The economic benefits
mentioned above could be in the form of an increase in assets or a decrease
in liabilities. When a company renders services or sells goods, it receives
cash as payment; thereby increasing assets. It can also acquire a receivable
if the sale was made on credit, or receive any other asset in place of cash.
Also, an existing liability may be forgiven or cancelled in exchange for the
company's services.
3. Increase in equity, other than contributions from equity participants - There are
only two elements that provide increases in equity: contributions from
owners and revenues or income.
List of Revenue Accounts
1. Service Revenue - revenue earned from rendering services. Other
account titles may be used depending on the industry of the business, such
as Professional Fees for professional practice and Tuition Fees for schools.
2. Sales - revenue from selling goods to customers. It is the principal
revenue account of merchandising and manufacturing companies.
o Sales Discounts - a contra-revenue account that represents
reduction in the amount paid by customers for early payment. It is shown in
the income statement as a deduction to Sales.
o Sales Returns and Allowances - also a contra-revenue account and
therefore shown as a deduction to Sales. Sales return occurs when there is
actual return of a defective item. Sales allowance happens when the customer
is willing to keep the item with a reduction in its selling price.
3. Rent Income - earned from leasing out commercial spaces such
as office space, stalls, booths, apartments, condominiums, etc.
4. Interest Income - revenue earned from lending money
5. Commission Income - earned by brokers and sales agents
6. Royalty Income - earned by the owner of a property, patent, or
copyrighted work for allowing others to use such in generating revenue
7. Franchise Fee - earned by a franchisor in a franchise
agreement
In the income statement, net income is computed by deducting all expenses
from all revenues. Revenues are presented at the top part of the income
statement before the expenses.

Expenses refer to costs incurred in conducting business.


Technically, expenses are "decreases in economic benefits during the accounting period in
the form of decreases in assets or increases in liabilities that result in decreases in equity,
other than those relating to distributions to equity participants".
From the long definition above, we can draw the following points:
1. Decrease in benefits during the accounting period - Expenses are measured from period to
period, and results in a decrease in economic benefits.
2. Decrease in assets or increase in liabilities - The decrease in economic benefits mentioned
above could be in the form of a decrease in assets or an increase in liabilities. When a
company incurs an expense, it pays cash; thereby decreasing assets. Besides cash, the
company may also use other assets in paying expenses. It may also incur in a liability in
cases of accrued expenses (unpaid expenses).
3. Decrease in equity, other than distributions to equity participants - There are only two
elements that decrease equity: distributions to owners (i.e., withdrawals or dividends) and
expenses.
List of Expense Accounts
1. Cost of Sales - also known as Cost of Goods Sold, it represents the value of the items
sold to customers before any mark-up. In merchandising companies, cost of sales is
normally the purchase price of the goods sold, including incidental costs. In manufacturing
businesses, it is the total production cost of the units sold. Service companies do not have
cost of sales.
o Purchases - cost of merchandise acquired that are to be sold in the normal
course of business. At the end of the period, this account is closed to Cost of Sales.
o Freight in - If the business shoulders the cost of transporting the goods it
purchased, such cost is recorded as Freight-in. This account is also closed to Cost of Sales at
the end of the period.
2. Advertising Expense - costs of promoting the business such as those incurred
in newspaper publications, television and radio broadcasts, billboards, flyers, etc.
3. Bank Service Charge - costs charged by banks for the use of their services
4. Delivery Expense - represents cost of gas, oil, courier fees, and other costs
incurred by the business in transporting the goods sold to the customers. Delivery expense
is also known as Freight-out.
5. Depreciation Expense - refers to the portion of the cost of fixed assets
(property, plant, and equipment) used for the operations of the period reported
6. Insurance Expense - insurance premiums paid or payable to an insurance
company who accepts to guarantee the business against losses from a specified event
7. Interest Expense - cost of borrowing money
8. Rent Expense - cost paid or to be paid to a lessor for the right to use a
commercial property such as an office space, a storeroom, a building, etc.
9. Repairs and Maintenance - cost of repairing and servicing certain assets such
as building facilities, machinery, and equipment
10. Representation Expense - entertainment costs for customers, employees
and owners. It is often coupled with traveling, hence the account title Travel and
Representation Expense.
11. Salaries Expense - compensation to employees for their services to the
company
12. Supplies Expense - cost of supplies (ball pens, ink, paper, spare parts, etc.)
used by the business. Specific accounts may be in place such as Office Supplies Expense, Store
Supplies Expense, and Service Supplies Expense.
13. License Fees and Taxes - business taxes, registration, and licensing fees
paid to the government
14. Telecommunications Expense - cost of using communication and telephony
technologies such as mobile phones, land lines, and internet
15. Training and Development - costs for the enhancement of employee skills
16. Utilities Expense - water and electricity costs paid or payable to utility
companies
And others, such as Accounting or Bookkeeping Fees, Legal and Attorney Fees, etc.Expenses are
deducted from revenues to arrive at the company's net income.

Test your accounting skills with this short quiz on Fundamental Accounting
Concepts under the Accounting 101: The Basics tutorial series.
Instructions: For each item below, write down what is required on a piece of
paper. You can check your answers later through the link at the end of the
quiz.
A. Identification and Fill in the Blanks
1. Under the accrual basis of accounting, income is recognized when
_____________ regardless of when _______; and expenses are recognized when
_______ regardless of when ________.
2. It refers to the assumption than an entity will exist indefinitely in the
absence of evidences that suggest otherwise.
3. It means that the indefinite life of an entity is subdivided into equal
periods.
4. __________ refers to a 12-month period ending in December 31.
5. __________ refers to a 12-month period ending in any month other than
December.
6. It means that a specific business enterprise is considered one
accounting entity, separate and distinct from its owners.
7. What are the two characteristics of the monetary unit assumption?
8. The ________________ states that expenses are recognized in the period
the related revenues are earned.
B. Determine if the given is a/n Asset, Liability, Capital, Income or Expense.
1. Prepaid Insurance
2. Light and Water
3. Employees' Salaries
4. Accounts Payable
5. Mr. Bruno, Capital
6. Accounts Receivable
7. Service Revenue
8. Service Equipment
9. Bonds Payable
10. Office Supplies
C. For each item, indicate whether it is a Current Asset (CA), Non-Current Asset
(NCA), Current Liability (CL), or Non-Current Liability (NCL).
1. Inventories
2. Prepaid Advertising
3. Accounts Payable
4. Bonds Payable, 3 yrs.
5. Accrued Rent Receivable
6. Cash in Bank
7. Land
8. Building
9. Delivery Equipment
10. Accounts Receivable
D. Case Problem. The following accounts pertain to the records of Sharkbait
Company at the end of the accounting period:
Assets $ 1,200,000 Revenues $ 500,000
Liabilities $ ? Expenses $ 300,000
The company started the year with $800,000 Capital. The owner made
$100,000 cash withdrawals during the year. No additional contributions were
made. How much is the total liabilities at the end of the period?
E. Accounting Process. Enumerate the 9 steps of the accounting process.
Write them in proper order.

Answers

Here are the answers to the short quiz on Fundamental Accounting Concepts.
You are free to review the lessons if you are having trouble with this section.
A. Identification / Fill in the Blanks
1. Under the accrual basis of accounting, income is recognized
when earned regardless of when collected; and expenses are recognized
when incurred regardless of when paid.
1 It refers to the assumption than an entity will exist indefinitely in the absence
of evidences that suggest otherwise. Going concern
2 The indefinite life of an entity is subdivided into equal periods. Time period
3 Calendar year refers to a 12-month period ending in December 31.
4 Fiscal year refers to a 12-month period ending in any month other than
December.
5 It means that a specific business enterprise is considered one accounting
entity, separate and distinct from its owners. Accounting entity concept
6 What are the two characteristics of the monetary unit assumption?
a. Quantifiability transactions are recorded in terms of money
b. Stability of the currency purchasing power of the dollar is stable
7 The matching principle/concept states that expenses are recognized in the
period the related revenues are earned.
B. Determine if the given is a/n Asset, Liability, Capital, Income or Expense.
1. Prepaid Insurance Asset
2. Light and Water Expense
3. Employees' Salaries Expense
4. Accounts Payable Liability
5. Mr. Bruno, Capital Capital
6. Accounts Receivable Asset
7. Service Revenue Income
8. Service Equipment Asset
9. Bonds Payable Liability
10. Office Supplies Asset
C. Indicate whether the account is a Current Asset (CA), Non-Current Asset
(NCA), Current Liability (CL), or Non-Current Liability (NCL).
1. Inventories CA
2. Prepaid Advertising CA
3. Accounts Payable CL
4. Bonds Payable, 3 yrs. NCL
5. Accrued Rent Payable CL
6. Cash in Bank CA
7. Land NCA
8. Building NCA
9. Delivery Equipment NCA
10. Accounts Receivable CA
D. Case Problem. The following accounts pertain to the records of Sharkbait
Company at the end of the accounting period:
Assets $ 1,200,000 Revenues $ 500,000
Liabilities $ ? Expenses $ 300,000
The company started the year with $800,000 Capital. The owner made
$100,000 cash withdrawals during the year. No additional contributions were
made. How much is the total liabilities at the end of the period?
Answer: $300,000. In solving this problem, the accounting equation A = L +
C is used. However, we need to compute for the balance of Capital first. We
know that Capital is increased by additional contributions and income,
and decreased by expenses and withdrawals. The capital ending balance and
liabilities are computed as follows:
Capital, beginning $ 800,000
Add: Revenues 500,000
Less: Expenses 300,000
Withdrawals 100,000
Capital, ending $ 900,000
Using A = L + C:
Liabilities $ 300,000
Capital (from above) 900,000
Assets (given) $ 1,200,000
E. Accounting Process. Enumerate the 9 steps of the accounting process.
Answer, in proper order:
1. Identifying and analyzing business transactions and events
2. Recording transactions in the journals
3. Posting entries to the ledger
4. Unadjusted trial balance
5. Preparing adjusting entries
6. Adjusted trial balance
7. Financial statements
8. Preparing closing entries
9. Post-closing trial balance
Adjusting Entries
Adjusting entries, also called adjusting journal entries, are journal entries made at the end of
a period to correct accounts before the financial statements are prepared. This is the fourth
step in the accounting cycle. Adjusting entries are most commonly used in accordance with
the matching principle to match revenue and expenses in the period in which they occur.

Adjusting Entry Types

There are three different types of adjusting journal entries. Each one adjusts income or
expenses to match the current period. This concept is based on the time period
principle which states that accounting records and activities can be divided into separate
time periods. In other words, we are dividing income and expenses into the amounts that
were used in the current period and deferring the amounts that are going to be used in
future periods.

AJEs are used to record:

Prepaid expenses or unearned revenues Prepaid expenses are goods or services that
have been paid for by a company but have not been consumed yet. Insurance is a good
example of a prepaid expense. Insurance is usually prepaid at least six months. This means
the company pays for the insurance but doesn't actually get the full benefit of the insurance
contract until the end of the six-month period. This transaction is recorded as a prepayment
until the expenses are incurred. The same is true at the end of an accounting period. Only
expenses that are incurred are recorded, the rest are booked as prepaid expenses.

Unearned revenues are also recorded because these consist of income received from
customers, but no goods or services have been provided to them. In this sense, the
company owes the customers a good or service and must record the liability in the current
period until the goods or services are provided.

Accrued expenses and accrued revenues Many times companies will incur expenses
but won't have to pay for them until the next month. Utility bills are a good example.
December's electric bill is always due in January. Since the expense was incurred in
December, it must be recorded in December regardless of whether it was paid or not. In this
sense, the expense is accrued or shown as a liability in December until it is paid.
Non-cash expenses Adjusting journal entries are also used to record paper expenses
like depreciation, amortization, and depletion. These expenses are often recorded at the
end of period because they are usually calculated on a period basis. For example,
depreciation is usually calculated on an annual basis. Thus, it is recorded at the end of the
year. This also relates to the matching principle where the assets are used during the year
and written off after they are used.

Recording AJEs

Recording adjusting journal entries is quite simple. The process includes three main steps:

-- Determine current account balance


-- Determine what current balance should be
-- Record adjusting entry

These adjustments are then made in journals and carried over to the account ledgers and
accounting worksheet in the next accounting cycle step.

Example

Following our year-end example of Paul's Guitar Shop, Inc., we can see that his unadjusted
trial balance needs to be adjusted for the following events.

-- Paul pays his $1,000 January rent in December.


-- Paul's December electric bill was $200 and is due January 15th.

-- Paul's leasehold improvement depreciation is $2,000 for the year.

-- On December 31, a customer prepays Paul for guitar lessons for the next 6 months.
-- Paul's employee works half a pay period, so Paul accrues $500 of wages.

Now that all of Paul's AJEs are made in his accounting system, he can record them on
the accounting worksheet and prepare an adjusted trial balance.

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