Before we begin, it is extremely important that you forget all of your preconceived notions of the words "debit" and "credit." You shouldn’t associate them with debit cards or credit cards. Neither debits nor credits are inherently good or bad. "Debit" and "credit" mean something very particular in the accounting world.
It's important to get that out of the way up front, it will save you a lot of pain later on if you can disassociate those terms now and start with a fresh perspective. Now that you know what not to do, let’s take a look at what those words actually mean.
"Debit" and "credit" most literally mean "left" and "right." That’s it, nothing more, nothing less.
Go back and read that again. One more time. It is imperative that you understand that the only meaning those words have is in relation to their sides, left or right. That’s not the tricky part. The (slightly) tricky part is remembering which accounts are normally debited or credited. Let’s take a look at the accounting equation:
The accounting equation must always be in balance, the left side (assets) must always be equal to the right side (liabilities and equity).
Let’s look at the equation in terms of left and right:
| Assets | = | Liabilities+ Shareholder's Equity |
| ← | → | |
| Left | Right | |
| Debits | Credits |
An increase to the left side of the equation is a debit (debit means left), and an increase in the right side of the equation is a credit (credit means right).
Now that we understand that the left side of the equation is increased by debits and the right side by credits, let’s turn to determining the normal balances for specific accounts. An account’s "normal balance" is simply the side of the account, either debit or credit, that is used to increase the value of that account.
It’s best that you don’t try to memorize the normal balance for every single account, that would be too tedious. Rather, try to learn the process used in determining whether it is a debit or a credit. Start with an easy one: assets.
Assets live on the left side of the equation. How do you increase the left side of the equation? With a debit, because debit means "left." That was easy enough. How then, would you decrease assets? Simply do the opposite of whatever you did to increase them, of course. If debits increase, credits decrease. In a visual format, you end up with the following, called a t-chart:
| Assets | |
| Debits | Credits |
| Increase | Decrease |
You’ve just logically determined for yourself how to increase and decrease the asset account, no memorizing required. To figure out any account, you simply have to remember 1) the accounting equation and 2) what debit and credit mean. Let’s try another basic one: liabilities.
Liabilities live on the right side of the equal sign. We know that the right side is for credits, therefore liabilities are increased with credits.
That leaves us with the following t-account (t-chart) for liabilities.
| Liabilities | |
| Debits | Credits |
| Decrease | Increase |
The same logic and result can be applied to the equity accounts:
| Equity | |
| Debits | Credits |
| Decrease | Increase |
These three accounts (assets, liabilities, and equity) are very simple to solve for, as they are clearly evident from the accounting equation. These provide for a great starting point before we get to slightly more complicated examples.
Some accounts, however, are not as obvious because they are not directly named in the accounting equation. Revenue, for example, is not directly mentioned in the equation. Neither are dividends or contra-assets. Don’t fret though, we simply have to keep using our previous framework, albeit a slightly extended version. Take revenues as our first challenge. (I'm assuming here that you have a basic of knowledge of revenues and expenses.)
Let’s trace the revenue account all the way through the closing process. (Remember that income statement accounts get closed at the end of every year.)
Revenues increase Net Income, which increases Retained Earnings, which increases Shareholder’s Equity. Therefore, revenues increase Shareholder’s Equity. That means that revenues will be increased in the same what that equity is increased. How is the Shareholder’s Equity account increased?
It’s on the right side, so it’s a credit. Revenues must be a credit too then.
It seems like a complicated process, so let’s do a quick recap. The three accounts in the accounting equation are easy to remember, based on the side of the equation they are on, so those should always be your endpoint. In the previous example, we needed to determine the effect of an increase in revenue on Shareholder’s Equity. Since an increase in revenue resulted in an increase in equity, and any account that increases the right side of the equation is a credit, revenue is a credit.
As a result, we have derived the t-account for revenue.
| Revenue | |
| Debits | Credits |
| Decrease | Increase |
As you can probably imagine, just as assets and liabilities have opposite normal balances, revenues and expenses have opposite normal balances. For those curious, here is the proof:
Now that we’ve done the hardest two, we’ll now turn to two more: Dividends and contra-accounts. First, dividends.
Accounting makes logical sense, as will be shown in this example: dividends decrease Retained Earnings, because it is money given to the shareholders and is therefore no longer retained. Even if you didn’t know what the effect of dividends is, you could get there logically. Retained Earnings is what the company retains, and since dividends are given back to the shareholders, dividends must reduce the Retained Earnings. It’s very important to try to learn instead of memorize because learning is much easier and much more effective. Carrying on: dividends reduce Retained Earnings, which reduces Equity, which means it is a debit.
Leaving us with the following t-chart:
| Dividends | |
| Debits | Credits |
| Increase | Decrease |
Finally, contra-accounts. Contra-accounts are accounts whose only purpose is to take away from some other account. Accumulated Depreciation, for example, is a contra-asset. It serves to decrease the value of long term assets, that is its only purpose. Sales returns are contra-revenues. When someone returns a product, it is no longer a revenue and must therefore be subtracted from revenue, hence: contra-revenue.
Determining the normal balance for contra-accounts is delightfully simple: it is the opposite of the account to which it is contra. The word "contra" means opposite, remember that.
Contra-asset? Assets are increased with debits, opposite of that is a credit.
Contra-liability? Liabilities are increased with credits, opposite is a debit.
Contra-revenue? Revenues are credits, contra-revenues are debits.
It really is as easy as that. Just take the opposite of the normal balance of the main account (whatever account the contra account is affecting).
Memorizing may seem easier at the time, but in the long run it will let you down. When you learn why things happen the way they do, i.e., why expenses are debited or why liabilities are credited, not only will you likely remember it longer, but then you can logically figure out things that may have been outside the scope of your memorization. Learning the fundamentals will serve you better every time.
That being said... If you absolutely refuse to learn, it’s better that you memorize than not know at all. This acronym can help you remember which accounts are debited.
Debit
Expenses
Assets
Dividends
You’ll be DEAD if you forget that you debit expenses, assets, and dividends. Corny? Absolutely. Will it work? Absolutely. What about credits? Well, if it’s not one of those three, it must be a credit, mustn’t it? One caveat is that it doesn’t manage contra-accounts very well. Use the same logic we used above to get to the solution. Contra-liability: liabilities are not on the DEAD list, therefore must be a credit, but we are dealing with contra-liabilities so take the opposite: debit.