Journal Entries: Debits and Credits - Online Tutor, Practice Problems & Exam Prep

Transactions in accounting involve giving something up and receiving something in return, impacting at least two accounts. The system of debits and credits is essential, where debits increase asset and expense accounts, while credits increase liability, equity, and revenue accounts. Each transaction must balance, ensuring total debits equal total credits. Understanding this balance is crucial for maintaining accurate financial records and adhering to the accounting equation, which is fundamental in the accounting cycle.

Journal Entries: Debits and Credits

Alright, now let's talk about transactions and the system of debits and credits. So transactions, these are things that are happening all the time, right? Every time something happens in the company, there is a transaction. So you give something up and you receive something in return. Alright? So if you buy some land, right? If you buy land, you give up cash for the land and you get land, right? If you sell something, right, you sell the product, you give up whatever inventory you had and you get revenue for selling that. Right? So let's talk about how this works. So every transaction is going to affect at least 2 accounts. And when I talk about accounts, that was like cash, accounts receivable, accounts payable, the investment account, retained earnings, whatever it is, there's going to be 2 accounts that we're going to affect at least when we do a transaction. Okay? And we're going to use this system of debits and credits. That's what they're called, to account for these transactions. So we're going to have some debits on the transaction and some credits. And what we're going to see is that every transaction must have an equal amount of debits and credits, okay? So when we record a transaction, we're going to record some debits in that transaction and we'll record some credits in that transaction and they have to equal each other. Alright?

So it's still kind of high level. You're going to see some examples down below, but here I want to show you how these accounts are going to work. We're going to see that asset accounts and expense accounts, they're going to increase with debits. Okay? So if you wanted to account for any if you receive some cash and you wanted to account for that, you would debit the cash account for that amount, okay? So that would be how we would increase the asset account, so you can imagine we could decrease an asset or an expense with a credit, right? So if we had to pay cash for something, we would credit the cash account in that amount. Alright, so it's the opposite with liabilities, equity, and revenue accounts. These accounts are increased with credits. Okay? So this isn't so much to memorize, but it is something worth just having it memorized and eventually it's just going to be second nature for you, but for now, it's really important to know that we're going to increase our our assets and our expenses with debits and we're going to increase our liabilities, our equity, and our revenue with credits. Okay? So that's how it's going to work. Let's pause here and I'm going to show you in an example. We're going to do a transaction and see how this works, alright? Let's do that below.

Journal Entry

Alright, so let's do this example. Fun Times Happy Company purchased a machine for $50,000; let's record the transaction. Okay, so this is what we're going to be doing a lot throughout this course: we are going to be given a sentence like this about the Fun Time Happy company, they purchased the machine and we have to analyze that sentence and turn it into a transaction where we have a journal entry with debits and credits here. Okay?

So, what they tell us is that we purchased a machine, so what we received was a machine. What did we give up to get that machine? We gave up $50,000 in cash, right? So we had $50,000, we don't have that anymore. Now we have a machine instead. Okay? So, remember a machine, what kind of account is that? Is that going to be an asset, liability, equity, revenue? Well, a machine is a long-term asset, right? It's a machine; it's something that the company owns, and we're going to use it for a long period of time. So a machine is an asset, right?

And what about cash? The cash that we paid, the $50,000 in cash, that's also an asset, isn't it? Right? So, remember our rules from above. We're going to increase assets with debits and we decrease assets with credits, okay? And remember that our debits have to equal our credits.

So, let me show you how we would write out this journal entry. Alright? When we start, you generally want to write your debits first, okay, and that would be your final journal entry, but when you're trying to figure out the entry and figuring out what's the debits, what's the credits, it doesn't matter what order you put them in. Just start organizing your debits and your credits, and you want them all to equal out. Okay?

So in this situation, we got a machine, so we need to increase the machine account by the amount of the cost of the machine. Okay? So in this case, we're going to debit Machinery. Machinery, let's say, would be the account where we keep the value of our machines. Okay? So we're going to put $50,000 like this. Okay? This is the debit entry. You can't really tell it's a debit or a credit yet. The way you tell the debit from a credit is the credits are going to be indented. Okay?

So, remember that since we paid $50,000 in cash, we don't have that cash anymore. We paid that out. We have to decrease our cash account. Since cash is an asset, we decrease it with a credit, right? So in this case, to show that it's a credit, we're going to indent, right? There's going to be this indentation where we write cash. So that signifies that it's a credit when we have the indentation, and we're also going to indent the number into a separate column over here. So the cash would also have $50,000, but it's a credit, right? These are the debits here, and these are the credits.

Okay. Notice that their debits equal the credits in this transaction, right? We increased our machinery by $50,000 and decreased our cash by $50,000 to account for this transaction. Okay? So this journal entry is complete. We have the accounts debited and credited that need to be included in the transaction.

And one more thing down here, we're going to kind of follow this format throughout the course just to kind of bring it back to that fundamental equation of assets equal liabilities plus equity. So what happened in this transaction? The machinery increased by $50,000, right? Our assets increased by $50,000 plus $50,000, but what else happened in this transaction? We also decreased our assets, right? We gave away $50,000 in assets to get $50,000 in assets. So it's kind of a wash when we look at it from the grand perspective. The level of assets stayed the same. It's just what kind of assets we have now, right?

So we'll see in other transactions when we start analyzing more, we're going to see transactions that affect liabilities, that affect equity. Here we had a case where we paid some cash, one of our assets, to get another asset. Okay? So let's go ahead and pause here, and in the next example, you guys can try and give it a shot and see if you can figure out the journal entry, and then we'll go through it together. Alright? Let's do that now.

The Goods Company purchased goods from its suppliers. The goods cost $20,000. Record the transaction.

The goods company purchased goods from its suppliers. The goods cost $20,000. Record the transaction. Okay, so in this situation, the company is buying goods. We're going to assume that they buy goods to resell them, right? What they do is that they buy goods, they have the goods, and then they find customers to sell them at a higher price, right? That's how they're going to make their money. But in this case, they're not selling anything; they're just buying goods, right? So in this case, what's going to happen is they're increasing their inventory of goods, right? So, what we're going to do is increase our inventory, and how did we pay for that inventory? We paid for it with cash, right? So the goods, let me circle the goods, that was inventory. Inventory right here. Let me scroll up a little, so you can see that. Inventory, let me also write it a little better. I don't like how that looks. Okay. And the $20,000 we paid for that inventory with cash. Right? It cost us $20,000, and we paid for it with cash, right? So what is inventory? Is inventory an asset, a liability, or equity? Well, given that it's goods that we own, they're in our warehouse or someplace, and we're waiting to sell it to customers, it has some value, and they have value stored there in the warehouse where we're waiting to sell those goods. Therefore, inventory is an asset and cash is also an asset, right? Did inventory go up or down? It went up, right? We bought some goods, so we have more inventory. So how do we increase the value of inventory? Well, remember that assets go up with debits and down with credits, right? So since inventory is going up, we want to debit inventory. We're going to put here that it's $20,000 worth, right? We spent $20,000; that's the value of the inventory. And then we have the other side, the credit side, right? Our debits have to equal our credits, so we're going to credit the cash account. Cash is going to go down by $20,000. Our debits equal our credits. This journal entry is complete. We've included all the information that was given to us, right? So what would happen after this journal entry? We would see that the value of our inventory account would go up by $20,000 and the value in our cash account would go down by $20,000. Right? And just like in our example, we're dealing with 2 assets here. Right? Inventory is an asset; cash is also an asset. Right? So since they're both assets, first, the inventory increases our assets by $20,000, and then the cash decreases our assets by $20,000, right? We got rid of $20,000 in cash to get this inventory. So again, our level of assets is going to stay the same. These are some simple examples. We're going to do a lot more examples to get you ready to analyze journal entries and transactions, alright? So let's go ahead and pause here and move on to the next video.

Here’s what students ask on this topic:

What is the difference between a debit and a credit in accounting?

In accounting, debits and credits are used to record transactions. A debit increases asset and expense accounts, while a credit increases liability, equity, and revenue accounts. For example, if you receive cash, you debit the cash account, increasing it. Conversely, if you pay cash, you credit the cash account, decreasing it. Each transaction must balance, meaning the total debits must equal the total credits. This system ensures accurate financial records and adherence to the accounting equation: Assets = Liabilities + Equity.

How do you record a transaction using debits and credits?

To record a transaction using debits and credits, identify the accounts affected and determine whether each account is debited or credited. For example, if a company buys equipment for cash, the equipment account (an asset) is debited, and the cash account (also an asset) is credited. The journal entry would look like this: Debit Equipment, Credit Cash. Ensure the total debits equal the total credits to maintain balance in the accounting equation.

Why must debits equal credits in every transaction?

Debits must equal credits in every transaction to maintain the balance of the accounting equation: Assets = Liabilities + Equity. This ensures that the financial statements accurately reflect the company's financial position. If debits and credits do not balance, it indicates an error in the recording process, which can lead to inaccurate financial reporting and potential issues in financial analysis and decision-making.

What accounts are increased with debits?

In accounting, asset and expense accounts are increased with debits. For example, when a company receives cash, the cash account (an asset) is debited, increasing its balance. Similarly, when an expense is incurred, the corresponding expense account is debited. This system helps in accurately tracking the company's financial transactions and maintaining the balance in the accounting equation.

What accounts are increased with credits?

Liability, equity, and revenue accounts are increased with credits. For instance, when a company earns revenue, the revenue account is credited, increasing its balance. Similarly, when a company incurs a liability, such as taking a loan, the liability account is credited. This system ensures that the financial records accurately reflect the company's obligations and earnings, maintaining the balance in the accounting equation.