In double-entry accounting, the main difference between debits and credits lies in how they affect the accounts within the accounting equation:
Assets = Liabilities + Equity
1. Debits
- Increase asset accounts (e.g., cash, inventory, equipment).
- Decrease liability accounts (e.g., loans, accounts payable).
- Decrease equity accounts (e.g., owner’s capital, retained earnings).
- Example: If a company buys a car for cash, the car (an asset) increases, and cash (an asset) decreases, both recorded as debits.
2. Credits
- Increase liability accounts (e.g., loans, accounts payable).
- Increase equity accounts (e.g., owner’s capital, retained earnings).
- Decrease asset accounts (e.g., cash, inventory, equipment).
- Example: If a company takes out a loan, the loan (a liability) increases, and cash (an asset) also increases, recorded as credits.
Key Concept:
- Every transaction involves at least one debit and one credit, and the total debits must always equal total credits to keep the accounting equation balanced.
Why This is Correct
This system ensures accuracy and balance in financial records. By maintaining the balance between debits and credits, double-entry accounting helps prevent errors and provides a clear view of the company’s financial position. This method is used globally, as it is the foundation for preparing financial statements, such as the balance sheet and income statement.
Proof:
- Double-entry accounting is the cornerstone of modern accounting, as endorsed by organizations like the Financial Accounting Standards Board (FASB) and International Financial Reporting Standards (IFRS).
- This system has been used since the 15th century and is widely adopted in financial reporting across industries.
