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I'm taking an accounting course and am finding that I don't understand exactly why "A credit decreases assets, such as inventory", for example.

I understand that selling creates a decrease in assets. But the course goes, "There must be a balancing decrease in equity, i.e., an expense" - why?

The words "credit" and "debit" seem to be completely arbitrary, as they are used to mean "increase" for some account types, and "decrease" for others.

I'm not the only Money.SE user confused by these terms. Is there an intuitive explanation perhaps, or a mnemonic I could just memorize?

Dan Dascalescu
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  • I notice a close vote without explanation. That isn't very constructive. If you are the close voter, or are thinking of voting to close the question, could you please comment to explain why, or how I could improve the question? Thanks :) – Dan Dascalescu Sep 06 '18 at 04:27
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    Unfortunately accounting questions are considered off-topic here. Double-entry bookkeeping is indeed quite old, so it's kind of like asking why we have numerator and denominator instead of something easier like top and bottom, they were accepted long ago as the terms and there's not an alternative good enough to buck hundreds of years of history. Once you get the hang of it you won't find any other terms easier to use either, because it's the whole system that takes some getting used to more than the terms used. – Hart CO Sep 06 '18 at 04:29
  • @HartCO: oh, I'm so sorry then. While researching the topic here, I saw another accounting question was answered, and there's an [tag:accounting] tag, so I had no idea accounting questions would be off-topic. Edit: I see a lot of accounting and double-entry bookkeeping questions in the right sidebar. – Dan Dascalescu Sep 06 '18 at 04:34
  • Yeah, there's no better stack exchange site for accounting questions, so I do think it's unfortunate that they are considered off-topic here. – Hart CO Sep 06 '18 at 04:37
  • I don’t understand the part about selling decreasing assets and equity. I thought that before accounting for profit/loss, selling just changes one kind of asset (tangible) into another (financial), leaving equity constant. Accounting for profit/loss then affects equity (and assets) - but only loss decreases equity. – Lawrence Sep 06 '18 at 12:04

2 Answers2

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The words "credit" and "debit" seem to be completely arbitrary, as they are used to mean "increase" for some account types, and "decrease" for others.

Is there an intuitive explanation perhaps, or a mnemonic I could just memorize?

First start with the accounting equation:

ASSETS = LIABILITIES + CAPITAL

The equation always balances. Every time. You can have transactions where an asset goes up and another asset goes down by the same amount. Therefore L & C don't change.

The wiki article you linked to:

If there is an increase or decrease in a set of accounts, there will be equal decrease or increase in another set of accounts. Accordingly, the following rules of debit and credit hold for the various categories of accounts:

  1. Assets Accounts: debit entry represents an increase in assets and a credit entry represents a decrease in assets
  2. Capital Account: credit entry represents an increase in capital and a debit entry represents a decrease in capital
  3. Liabilities Accounts: credit entry represents an increase in liabilities and a debit entry represents a decrease in liabilities
  4. Revenues or Incomes Accounts: credit entry represents an increase in incomes and gains, and debit entry represents a decrease in incomes and gains
  5. Expenses or Losses Accounts: debit entry represents an increase in expenses and losses, and credit entry represents a decrease in expenses and losses

Looking at the first 3 rules and the accounting equation:

|----ASSETS---| = |-LIABILITIES-| + |---CAPITAL---|
|   -  |   +  |   |  -   |   +  |   |  -   |  +   |
|Credit| Debit|   |Debit |Credit|   |Debit |Credit|

So it appears if they are on the right side they make sense Debit = minus, if they are on the left they are the opposite.

Revenue and Expenses are not a part of the accounting equation. Some entries will be echoed in the Revenue and Expenses but not all will be. If you get a loan Assets go up, you got cash; but Liabilities go up becasue you have to pay it back. There is no change to revenue or expenses in this example.

But to continue with the last two rules:

|---REVENUE---| minus |---EXPENSE---| = |---PROFIT---|
|   -  |   +  |       |  -   |   +  |   
|Credit| Debit|       |Credit| Debit|

The why? no idea. But you were looking for a way to memorize.

mhoran_psprep
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@mhoran_psprep gives a good response, however, I would differ on the concept that Revenue and Expenses are not part of the accounting equation[.] in that these two elements are (conceptually, anyway) 'sub-classes' to the Capital side of the equation. When reported on the Balance Sheet, R&E are netted to Capital as either Net Profit or Net Loss as of the Balance Sheet (BS) reporting date. It should be noted that (typically) the Balance reports an 'As Of' date (versus a specific period, such as a month, quarter or year), meaning that all balances being reported (including Revenues & Expenses) are from inception through the report date. The implication here is the Net Profit/Loss may not match the Profit and Loss (P&L) report because the latter is typically reported for a specific period, therefore if the P&L were also run from inception through the same report date of the BS, the net should then be the same as reported on the BS... but I digress.

IMHO the concepts of Debit and Credit vis-a-vis Increase and Decrease haunts many accounting beginners (no slight intended) -- I, for one, struggled with these concepts for years. Further complicating matters, was the idea that my bank debit card decreases my bank account??? In the beginning, I found the rote memorization really was the solution until...

I found the mnemonic and process that worked for me:
1. Assets: Debits = Deposits (or any increases to the asset account); C = Checks (or any decreases to the asset account).
2. Liabilities & Capital, Revenues & Expenses: Are the opposite of the effect upon the Assets.
3. Contra-Assets (eg depreciation accrual accounts, not included in the discussion, but worth mentioning) are also the opposite (contra) of Asset Accounts.

My process is to first determine the effect on an Asset Account, such as Cash or Bank, and proceed from there:

Examples:

  1. Received money for sales of goods: Received = Deposit (increase) to Cash/Bank, therefore Debit, thus (as there must be an offset) Sales (or revenues - obviously is not an expense) receives the Credit (an increase of sales).
  2. Paid utility expense. Paid = Check (or decrease) from cash/bank and therefore Credit, thus the expense account receives the offsetting debit (an increase of the expense).
  3. Issued invoice for sale of widgets on account: Increased (Debit) Accounts Receivable (an Asset), Credit Sales (increase Sales).
  4. Received payment on invoice (#3): (two asset accounts!!) Received money = Deposit = Debit to bank (Increase), offset Credit Accounts Receivable (decrease amount owed)
  5. Received bill for inventory; bill is due in 30 days: This one is a bit more complicated because timing of receipt of goods may not coincide with the presenting or due date of the bill, however for the sake of discussion, inventory was received at the time the bill was presented: Inventory, an Asset, items 'deposited'/increased our inventory therefore Debit. Credit (increases) Accounts Payable for the Bill amount due net 30.
  6. Pay Bill (#5): Check (credit, decrease) from Asset account Cash/Bank, Debit (decreases) Accounts Payable amounts still owed by company.

Hold the phone... I just said Debits=Deposits and Checks= Credits, so why does the bank statement list checks as debits and Deposits as Credits??? Because the bank issues its statements from its own perspective NOT the account holder's perspective. This may get a little confusing because we list the bank in our company's Chart of Accounts -- which is true, but that is OUR Chart of Accounts. From the Banks Perspective, the money on deposit at the bank (the Bank's Asset) does not belong to the bank, it is a liability the bank owes to the account holder. As the account holder appears as a liability, when the account holder deposits money at the bank the bank records as a Debit to its vault (SIC) but must offset Credit (increase) the amount for the account holder. When a debit card transaction or check is processed, the bank takes (Credit/decreases) the money from it's vault (SIC) and sends it to the payee/receiver -- the Liability (the amount the bank now owes the Account Holder) is decreased (debited)

Jbowman
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