Demystifying Debits and Credits

Many non-accountants don’t understand debits and credits. I’ve met accountants who don’t really understand them either. Years ago, I had a job interview and my would-be boss was the interviewer. We were well into the interview when he said that he had a question to ask me. It was a question that was asked to him in an interview and it stumped him. As a result, he now asks it whenever he interviews someone. This made me a little nervous, but told him to fire away. He asked, “What is a debit and credit?” After experiencing a brief moment of silent relief, I quickly replied, “Debit means left side and credit means right side.” My answer was correct, but I was deeply concerned that this question stumped someone who I would have to call my boss if I took the job. I was called back for a second interview and declined solely because of that reason.

So yes, debit means left side and credit means right side. You cannot readily attach the words “increase” or “decrease” to a debit or credit like so many people try to do - because it depends. Back in the day before computers were around, accounting was done on paper, usually in a two-column ledger book. Accounting works on a double-entry system. The dollar amount entered in the left column equals the dollar amount entered in the right column and at least two entries had to be made to make that happen. The left and right sides had to “balance”.

As far as increasing or decreasing an account balance, you only need to remember two basic rules with some exceptions: 1) If you want to increase an asset or expense account, debit the account and 2) If you want to increase a liability, equity, or revenue account, credit it. If you want to decrease said accounts, do the opposite of rules 1 and 2. The exceptions are contra accounts, which are beyond the scope of this article.

Here’s a simple example. You received $100 for services rendered and deposited it in your bank account. You increased your bank account, an asset, so you debit Cash for $100. You also increased your revenue. You made money. You credit Revenue for $100. So you have $100 on the left side (debit) and $100 on the right side (credit). It’s balanced!

The one thing that confuses everyone on debits and credit is the bank. If they put money in your account, like a service charge refund, they say they are crediting your account. But wait! Your cash just increased so why is the bank calling it a credit? Because they are looking at it from their end, not yours. Their account just decreased because they gave you money so it’s a credit to them.

I wrote this article for two reasons. First, I wanted to demystify debits and credits, as the title suggests, to small business owners who do their own accounting but aren’t accountants. I hope this small insight provides a little more accounting knowledge to entrepreneurs and elevates their confidence in doing their own books. Second, this might be a great interview question to ask if you’re currently hiring for an accounting position. An applicant’s answer will be very telling as to how firm their grasp is on basic accounting principles. If you’re looking for an adept accountant who can “hit the ground running”, they should be able to answer this question without thought or hesitation. Unless, of course, they are shocked that it’s even asked. I know I was.