Here is some general guidance on analyzing transactions using the debit and credit recording system.
The most common transactions involve revenue and expense accounts. When a firm sells products or provides services it earns revenue, so a revenue account must be increased. This means a revenue account must receive a credit. The offsetting debit is always to an asset account, most commonly Cash or Accounts Receivable. When a firm incurs an expense, an expense account must receive a debit. The offsetting credit is almost always either to Cash or to Accounts Payable.
The next most common transactions involve cash payments and receipts associated with Accounts Payable and Accounts Receivable. An accounts payable is a liability the firm incurs in exchange for goods and services it receives. When the firm makes a cash payment to reduce such a liability, Accounts Payable receives a debit and Cash receives the offsetting credit. An accounts receivable is a customer’s or client’s promise to pay for goods or services it has previously received. An accounts receivable is an asset. When the firm receives a payment from the customer to repay their account, Accounts Receivable receives a credit and Cash receives the offsetting debit.
Less frequently the firm will be involved in financing transactions. In a financing transaction the firm is either receiving or repaying a loan. When the business receives the loan the Cash account is debited and the Notes Payable account is credited. When the firm makes a repayment the Notes Payable account is debited and Cash is credited. This is the correct posting for repayment of loan principal. Interest payments on loans are expenses and the correct entry for the repayment of interest is a debit to the Interest Expense account and an offsetting credit to Cash.
The acquisition of fixed assets is another class of relatively infrequent transactions. When a firm acquires a fixed asset, such as equipment or office furniture, the appropriate asset account is debited. The offsetting credit is to Cash if the firm pays for the asset immediately, or to Notes Payable if the payment will be deferred until after the acquisition.
Finally, there are the infrequent transactions between the firm and its owners. Usually these involve cash transfers to and from the owners. If an owner contributes cash to their firm, Cash is debited and an appropriate equity account, such as Owner’s Equity, is credited. When a firm distributes cash to owners, Cash is credited and an account, such as Owner’s Draws, is debited.
The above types of transactions do not exhaust the possible types of transactions but account for the most common activities that a business engages in.
Hard copy $4.95