What it means
The rule that confuses newcomers is that "credit" does not mean "increase" or "good". It means the right side of a T-account, and what a right-side entry does depends on the type of account.
Liabilities, equity and revenue naturally sit on the right side of the accounting equation, so a credit increases them. Assets and expenses naturally sit on the left, so a credit decreases them.
When a company makes a sale on account, it debits receivables (an asset goes up) and credits revenue (revenue goes up). When it pays a supplier, it debits accounts payable (a liability goes down) and credits cash (an asset goes down).
The bank statement is the usual source of confusion. When your bank says it has credited your account, it means it has increased what it owes you, because your deposit is a liability from the bank's point of view.
In your own books the same deposit is a debit to cash, an asset. Both are correct; they are written from opposite sides of the same relationship.
A useful memory aid is that debits and credits mirror the accounting equation. Assets = Liabilities + Equity.
Accounts on the left of the equation increase with debits; accounts on the right increase with credits. Revenue increases equity, so it behaves like equity and increases with credits.
Expenses reduce equity, so they behave like assets and increase with debits. The commercial meanings of credit connect to the same idea.
When a supplier extends credit, it accepts a receivable, an asset, in place of cash, and the customer records a payable, a liability, with a credit entry. Credit terms, credit limits, credit control and credit risk all concern that relationship between a party who has delivered and a party who has yet to pay.
In practice
Real-world examples.
Example
A shop receives $500 in cash from a customer: debit cash, credit sales revenue.
Example
A company borrows $100,000 from the bank: debit cash, credit bank loan (a liability increases with a credit).
Example
A business grants a customer a refund on a returned item: debit sales returns (a contra revenue), credit cash.
Think of it
“Credits are like the opposite end of a seesaw from debits. When one side goes up, the other must go down to keep everything balanced.
Formula
Calculation
Total Debits = Total Credits, for every transaction and for the ledger as a whole
Normal balances: Assets and Expenses are debit balances; Liabilities, Equity and Revenue are credit balances
Worked example. A small design agency records five transactions:
1. The owner invests $50,000 cash. Debit cash $50,000 (asset up); credit share capital $50,000 (equity up).
2. The agency buys a computer for $3,000 on credit from a supplier. Debit equipment $3,000 (asset up); credit accounts payable $3,000 (liability up).
3. It invoices a client $8,000 for completed work. Debit accounts receivable $8,000 (asset up); credit revenue $8,000 (revenue up).
4. It pays $2,000 rent in cash. Debit rent expense $2,000 (expense up); credit cash $2,000 (asset down).
5. It pays the computer supplier. Debit accounts payable $3,000 (liability down); credit cash $3,000 (asset down).
Check: debits total $50,000 + $3,000 + $8,000 + $2,000 + $3,000 = $66,000; credits total the same $66,000.
Resulting balances: cash $45,000 debit, receivables $8,000 debit, equipment $3,000 debit, payables zero, share capital $50,000 credit, revenue $8,000 credit, rent expense $2,000 debit. Assets ($56,000) = Liabilities ($0) + Equity ($50,000 + $8,000 minus $2,000 = $56,000).Case study
Seen in the real world.
A new bookkeeper at a small wholesaler, thinking of credits as increases, recorded three months of supplier payments as credits to accounts payable rather than debits. The payables balance grew each month instead of falling, the owner became convinced the business was drowning in unpaid bills, and cash was correctly reduced so the two sides of the trial balance no longer agreed. The external accountant traced the problem in an afternoon by noticing that payables had risen by exactly the amount of the quarter's supplier payments.
Reversing the entries restored a payables balance of $30,000 rather than the $190,000 shown, and the owner's alarm turned out to have been misplaced. The accountant's fix for the future was a one-page card taped to the monitor: assets and expenses up with debits, liabilities, equity and revenue up with credits, and every entry must have both.
Watch out
Common mistakes.
- Assuming credit means increase or means good. It is a side of the ledger; its effect depends on the account type.
- Confusing the bank's credit to your account (its liability increases) with a credit in your own books (your cash asset would decrease).
- Recording a transaction with only one side. Every debit needs an equal credit.
Questions
People also ask.
Does a credit increase or decrease an account?
It increases liabilities, equity and revenue, and decreases assets and expenses.
What is a credit balance?
A balance where credits exceed debits. It is normal for liabilities, equity and revenue, and unusual for an asset (a credit balance in cash means an overdraft).
How does credit in bookkeeping relate to buying on credit?
Buying on credit creates a liability, accounts payable, which is recorded with a credit entry. The two uses of the word connect through that liability.
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