Understanding T- Accounts Debits and Credits
In this article, we will cover the Understanding T- Accounts Debits and Credits
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Understanding T- Accounts Debits and Credits
Understanding Debits and Credits in Accounting
Are you struggling to grasp the concept of debits and credits in accounting? You are not alone! Many find this fundamental topic challenging, but with the A-D-E-L-E-R approach, you can understand and retain it more effectively. While memorization is helpful, true comprehension is invaluable.
Establishing the Normal Balance of Accounts
A key starting point in understanding debits and credits is recognizing the normal balance of an account. The DC, ADE, LER framework simplifies this:
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DC – Debits on the left, Credits on the right.
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ADE – Assets, Dividends, and Expenses have a normal debit balance (left side).
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LER – Liabilities, Equity, and Revenue have a normal credit balance (right side).
(Some references use "Drawings" instead of "Dividends.")
The Accounting Equation
Before diving deeper, let’s establish the foundation:
Assets=Liabilities+Equity\text{Assets} = \text{Liabilities} + \text{Equity}
Also known as the Balance Sheet Equation, this principle underpins financial reporting.
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Assets (OWN) – Represent what a company owns and have a normal debit balance.
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Liabilities (OWE) – Represent what a company owes and have a normal credit balance.
Practical Examples
1. Asset Example – Inventory
Inventory, classified as an asset, starts with a debit balance. Consider the following transactions:
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Opening balance: 200 debit
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Inventory received: +70 debit
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Inventory shipped: −50 credit
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Ending balance: 220 debit
2. Liability Example – Accounts Payable
Accounts payable, a liability account, follows a credit normal balance. Observe the transactions:
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Opening balance: 300 credit
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New supplier invoices: +70 credit
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Payments made: −120 debit
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Ending balance: 250 credit
Connecting Debits and Credits
Notice the 70 appearing in both examples. The company received $70 worth of inventory but did not pay immediately. Instead, an invoice was recorded in accounts payable. The journal entry is:
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Debit Inventory 70 (increasing an asset)
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Credit Accounts Payable 70 (increasing a liability)
Every accounting transaction affects at least two accounts, ensuring that total debits always equal total credits.
The Role of Equity and Revenue
The "E" in LER represents Equity, which includes shareholder capital. Revenue, a key component of equity, has a normal credit balance because earning revenue increases equity.
However, generating revenue incurs expenses, which have a normal debit balance since they reduce equity. The difference between revenue and expenses determines profitability:
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Revenue > Expenses → Profit (increases equity)
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Revenue < Expenses
→ Loss (decreases equity)