2 Accounts, Debits, and Credits

Accounts and account categories

An account tracks increases, decreases, and the balance of one item in a business’s financial records. Examples include Cash, Accounts Receivable, Equipment, Accounts Payable, Service Revenue, and Rent Expense. Accounts are maintained in the general ledger.

The chart of accounts

The chart of accounts is the organized list of accounts a business uses. It groups accounts by type and commonly arranges balance-sheet accounts first, followed by income-statement accounts. Businesses can tailor the list to their operations, so account names and numbering systems may differ. For example, one business might use account 101 for Cash and 401 for Service Revenue. The chart helps staff classify transactions consistently.

The main account categories are:

• Assets: Resources the business controls, such as cash, inventory, and equipment.

• Liabilities: Amounts the business owes, such as Accounts Payable or a bank loan.

• Equity: The owners’ residual interest in the business, including owner contributions and accumulated earnings.

• Revenues: Amounts earned from providing goods or services.

• Expenses: Costs incurred to earn revenue, such as wages, rent, or utilities.

Revenues increase equity, while expenses and owner withdrawals or dividends decrease it. Revenue and expense accounts therefore provide detail about changes in equity during a period.

Debits, credits, and double-entry bookkeeping

A T-account represents an account with the debit side on the left and the credit side on the right. Debit and credit mean left and right, not inherently “increase” and “decrease.” Whether an entry increases an account depends on its type.

In double-entry bookkeeping, each transaction has at least one debit and one credit, and total debits must equal total credits. A transaction may affect more than two accounts.

Normal balances and decreases

The normal balance is the side on which increases are usually recorded and on which an account’s balance normally rests. The normal balance and usual increase side vary by account type:

• Assets, expenses, and owner withdrawals or dividends normally increase with a debit and have debit balances.

• Liabilities, equity accounts such as owner capital, and revenues normally increase with a credit and have credit balances.

To decrease an account, record the entry on the side opposite its normal balance. Crediting Cash decreases that asset; debiting Accounts Payable decreases that liability.

Some contra accounts have a normal balance opposite to the related account. For example, Accumulated Depreciation normally has a credit balance because it reduces an asset’s reported amount.

The accounting equation

The accounting equation expresses that a business’s resources are financed by creditors, owners, or both:

Every correctly recorded transaction keeps the equation in balance. The equity side can be expanded to show how owner contributions, revenues, expenses, and withdrawals affect it:

For a corporation, contributions and withdrawals are commonly represented by stockholders’ equity accounts such as common stock and dividends. Revenues add to equity, while expenses and distributions reduce it.

Transaction examples

These transactions show how account changes, debits, credits, and the accounting equation fit together:

• Owner invests cash: Debit Cash $\$10{,}000$; credit Owner Capital $\$10{,}000$. Assets increase by $\$10{,}000$, and equity increases by $\$10{,}000$.

• Business buys equipment with cash: Debit Equipment $\$2{,}000$; credit Cash $\$2{,}000$. One asset increases by $\$2{,}000$ and another decreases by $\$2{,}000$, leaving total assets unchanged.

• Business buys supplies on account: Debit Supplies $\$500$; credit Accounts Payable $\$500$. Assets and liabilities each increase by $\$500$.

• Business earns cash for services: Debit Cash $\$900$; credit Service Revenue $\$900$. Assets increase by $\$900$, and equity increases through revenue by $\$900$.

• Business pays rent for the current period: Debit Rent Expense $\$300$; credit Cash $\$300$. Assets decrease by $\$300$, and equity decreases through expense by $\$300$.

Analyzing a transaction

To analyze a transaction:

1. Identify which accounts change.

2. Classify each account.

3. Determine whether each balance increases or decreases.

4. Assign debits and credits using the normal-balance rules.

5. Check that total debits equal total credits and that the accounting equation remains balanced.

• contra account