Debit Credit Equation
Debit Credit Equation
Let's find out what Normal Account Balances are.
In bookkeeping, the concept of a normal balance is the foundation of the double-entry accounting system. Simply put, an account's normal balance is the side of the account—either Debit (left) or Credit (right)—where an increase is recorded.
Think of it as the account's "home base" or natural state. While an account can have a balance on the opposite side temporarily, it should normally carry a positive balance on its designated side.
The Major Accounts Normal Balance:
- Assets have a Normal Debit Balance
- Liabilities have a Normal Credit Balance and the
- Equity Accounts have the following Normal Balances:
- Owner's Capital has a Normal Credit Balance
- Owner's Retained Earnings has a Normal Credit Balance
- Revenue has a Normal Credit Balance
- Draws and Dividends have a Normal Debit Balance
The "Why" Behind Draws, Expenses, and Revenue
You might wonder why Draws and Expenses have a Normal Debit Balance if they are part of Equity which has a Normal Credit Balance.
Revenue increases Equity (Capital), so it shares Equity's Normal Credit balance.
Draws and Expenses decrease Equity (Capital), so they have a Normal Debit Balance. To show a decrease to Equity we use a debit.
Therefore, recording a draw or an expense means debiting the draw or expense account to track how much equity has been reduced.
A Handy Memory Trick Revisited: DEALER
A classic and highly effective acronym used to remember normal balances is splitting them into two groups: DEA and LER.
DEA (Normal Debit Balance)
These accounts are increased with a Debit (Normal Balance): and decreased with a Credit
- Dividends / Drawings
- Expenses
- Assets
LER (Normal Credit Balance)
These accounts are increased with a Credit (Normal Balance): and decreased with a Debit
- Liabilities
- Owner's Equity
- Revenue
Mastering the normal balance of these five account types makes analyzing transactions and troubleshooting errors in a general ledger much more straightforward.
Now we'll explore the Debit and Credit Equation: Draws/Dividends + Expenses + Assets = Liabilities + Owner's Capital +Revenue
To understand how we get to the final debits and credits equation, we have to look at how the fundamental accounting equation expands, and then use some basic algebra to rearrange it.The goal is to get all the accounts that increase with a debit on one side, and all the accounts that increase with a credit on the other.
Here is the step-by-step breakdown of how we convert it.
Step 1: The Base Accounting Equation
Every business starts with the foundational concept that everything the business owns (Assets) is financed either by borrowing money (Liabilities) or by the owner's own money (Equity).
Basic Accounting Equation Assets = Liabilities + Equity
Step 2: Expanding Equity
Equity isn't static; it changes constantly based on business operations. We expand the Equity portion of the equation to show exactly what increases it and what decreases
it:
- Owner's Capital (Investment): Increases Equity.
- Revenues: Increase Equity
- Expenses: Decrease Equity
- Draws / Dividends: Decrease Equity
When we substitute these into the base equation, we get the Expanded Accounting Equation:
Assets equal Liabilities plus Equity (Owner's Capital) plus Revenues minus Expenses minus Draws/Dividends.
Step 3: Eliminating the Negative Signs (The Algebraic Pivot)In traditional accounting, we don't like dealing with negative signs in our core equations.
To get rid of the minus signs next to Expenses and Draws/Dividends, we use basic algebra: we move them to the left side of the equals sign.
When you move a negative term across the equals sign, its sign changes to positive.
- Move Draws/Dividends to the left side + Draws/Dividends.
- Move Expenses to the left side + Expenses.
Now, the equation looks like:
Draws/Dividends + Expenses + Assets = Liabilities + Equity (Qwner's Capital) + Revenue
Why This Matters: The Debit and Credit Rule.
This final algebraic layout perfectly mirrors the rules of double-entry bookkeeping. The equals sign acts as a dividing wall:
The Left Side (DEBITS)
- Draws/Dividends + Expenses + Assets
- These accounts sit on the left side of the equation.
- Therefore, their normal balance is a Debit (which means "left").
- To increase any of these accounts, you Debit them.
The Right Side (CREDITS)
- Liabilities + Capital (Equity) + Revenue
- These accounts sit on the right side of the equation.
- Therefore, their normal balance is a Credit (which means "right").
- To increase any of these accounts, you Credit them.
This equation becomes a foolproof map for matching transactions to their proper debit and credit columns.
Did you see how this equation is also derived from the DEALER Acronym ?
Now, it should be simple to determine when to debit or credit an account when entering transactions using the Debit and Credit Equation.
Debit and Credit Equation: Draws/Dividends + Expenses + Assets = Liabilities + Equity (Qwner's Capital) + Revenue
Our New "Debit Credit Rule"
The types of accounts on the left side of the equation use a debit to increase and a credit to decrease an account's balance.
The types of accounts on the right side of the equation use a credit to increase and a debit to decrease an account's balance.
Debit and Credit Equation
Draws / Dividends + Expenses + Assets = Liabilities + Owner’s Equity + Revenue
Normal Debit Balances = Normal Credit Balances
Debit Balance Accounts = Credit Balance Accounts
In this equation all the normal debit balance accounts are on the left side of the equal sign and all the normal credit balance accounts are on the right side of the equal side.
Debit Credit Rule:
All the type of accounts on the left side of the equation with a normal debit balance are increased with a debit and decreased with a credit.
All the type of accounts on the right side of the equation with a normal credit balance are increased with a credit and decreased with a debit.