Rules of Debit and Credit
Why did we record increases in the cash account as debits and decreases as credits?
The simple answer is because of convention. That is, a standardized method of record-
ing increases and decreases in accounts is essential in order that businesses record
transactions in a similar manner. If each business recorded transactions differently, the
result would be chaotic and comparability between companies would be lost.
The standardized rules of debit and creditare incorporated into the accounting
equation as shown in Exhibit 3. These standardized rules are used by all businesses—
from the corner gas station to the largest public corporation.
Exhibit 3 shows three important characteristics of the rules of debit and credit.
First, thenormal balance of an accountis the side of the account used to record in-
creases. Thus, the normal balance of an asset account is a debit balance, while the nor-
mal balance of a liability account is a credit balance. This characteristic is often useful
in detecting errors in the recording process. That is, when an account normally having
a debit balance actually has a credit balance, or vice versa, an error may have occurred
or an unusual situation may exist.
To illustrate, assume that at the end of the period the cash account has a credit bal-
ance. In this case, either an error has occurred or the company has overdrawn its bank
account. Likewise, if accounts payable has a debit balance, then an error has occurred
or the company has overpaid its accounts payable. On the other hand, a credit balance
in the office equipment or land account can only result from an error in the recording
process. That is, a company cannot have negative office equipment or land. Thus, the
normal balances of accounts provide a degree of control in the recording process.
Thesecondcharacteristic shown in Exhibit 3 is that accounts on the left side of the
accounting equation (the assets side) are increased by debits and have normal debit
balances, while accounts on the right side of the accounting equation (liability and
stockholders’ equity side) are increased by credits and have normal credit balances. On
the asset (left-hand) side of the equation, the only exception to the preceding relation-
ship is that some asset accounts, called contra asset accounts, are normally increased
by credits and have normal credit balances. As the name contra asset implies, these ac-
counts offset the normal debit balances of asset accounts. For example, accumulated
depreciation, an offset to plant assets, is increased by credits and has a normal credit
balance. Thus, accumulated depreciation is a contra asset account. We will discuss the
concept of depreciation and accumulated depreciation in more depth in Chapter 9.
On the liability and stockholders’ equity (right-hand) side of the equation, the only
exceptions to the preceding relationship are the dividend and expense accounts. The
payment of dividends decreases stockholders’ equity (retained earnings); thus, the div-
idends account is increased by debits and has a normal debit balance. In this sense, the
dividends account can be thought of as a type of offset to retained earnings.
Revenue increases stockholders’ equity (retained earnings), and thus revenue ac-
counts are increased by credits and have normal credit balances. In contrast, expenses
decrease stockholders’ equity (retained earnings). Thus, expense accounts are increased
by debits and have a normal debit balance. Expense accounts can be thought of as a
type of offset to revenues.
Thethirdcharacteristic of the rules of debit and credit is that for each transaction the
total debits will equal the total credits. That is, each transaction must be recorded so that
the total debits for the transaction will equal the total credits. For example, assume that
a company pays cash of $500 for supplies. The asset account Supplies will be debited (in-
creased) by $500 and Cash will be credited (decreased) by $500. Likewise, if the company
provides services and receives $2,000 from customers, Cash will be debited (increased)
and Fees Earned will be credited (increased) by $2,000. Debits equaling the credits for
each transaction provides a degree of control in the recording process. In addition, as
shown in Exhibit 3, the equality of debits and credits for each transaction is built into the156 Chapter 4 Accounting Information Systems
Q.If $500 is debited to
an account, on which side
of the account is it en-
tered? Is the account in-
creased or decreased?A.The $500 is entered on
the left side of the ac-
count. Whether the $500
increases or decreases the
account depends on what
kind of account is
involved.