Review this quick guide to recording debits and credits. It will be necessary for you to commit the rules for debits and credits to memory before you move forward in this course.
Note: This are general guidelines and we will have exceptions to these rules. Then we translate these increase or decrease effects into debits and credits. Balance Sheet accounts are assets, liabilities and equity. The balance sheet proves the accounting equation. Recording transactions into journal entries is easier when you focus on the equal sign in the accounting equation. There is an exception to this rule: Dividends or withdrawals for a non-corporation is an equity account but it reduces equity since the owner is taking equity from the company.
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It does, however, impact the available funds you have to operate your business. This number is important to potential investors because it helps them understand your net worth. Yes, we took the circuitous route to get back to the question about debits and credits, but understanding how your business account works, and how an asset or liability affects an accounting entry was important before we got back to the question of whether expenses are a debit or credit.
Again, because expenses cause stockholder equity to decrease, they are an accounting debit. First of all, any expense you have is hopefully for the betterment of your business. Your salaries expense allows you to bring in the brightest people in your industry to help you grow the company.
Raw materials expenses allow you to create finished goods you can then sell for a profit. Even the accounting software you pay for each month helps you stay organized with each accounting transaction. Expenses also reduce your credit accounts, which means you are taxed on a lower annual revenue number. Need a better way to manage expenses and cash flow? Even if your accounting software automatically downloads each liability transaction and invoice, you still should be involved with your accounts, adjusting entries when needed.
Inventory is a current asset, and the company pays for the inventory with cash. The journal entry would look like this:. Inventory is an asset account. It has increased so it's debited and cash decreased so it is credited. Here is a tip about how to handle the cash account:.
When cash is received, the cash account is debited. When cash is paid out, the cash account is credited. Cash, an asset, increased so it would be debited. Fixed assets would be credited because they decreased. Liabilities are what the company owes to other parties. They can be current liabilities, like accounts payable and accruals, or long-term liabilities, like bonds payable or mortgages payable.
Here's the rule for liability and equity accounts. Increases are debits and decreases are credits. You would debit notes payable because the company made a payment on the loan, so the account decreases. Cash is credited because cash is an asset account that decreased because cash was used to pay the bill. The owner's equity accounts are also on the right side of the balance sheet like the liability accounts.
Examples are common stock and retained earnings. They are treated exactly the same as liability accounts when it comes to accounting journal entries. Here is an example of a journal entry for the owner's equity account.
The common stock of the business is selling at its par value. Here's the resulting journal entry:. According to Table 1, cash increases when the common stock of the business is purchased. Cash is an asset account, so an increase is a debit and an increase in the common stock account is a credit. Expense accounts are items on an income statement that cannot be tied to the sale of an individual product.
Of all the accounts in your chart of accounts, your list of expense accounts will likely be the longest. Expense accounts run the gamut from advertising expenses to payroll taxes to office supplies.
It's imperative that you learn how to record correct journal entries for them because you'll have so many.
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