Debit Definition & Meaning

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KEY TAKEAWAYS

• Debits decrease liabilities and increase assets.
• Debits are used to record the expenses incurred by you or your business.
• Double-entry accounting is essential for debit transactions.
• Understanding debits and credits is a must for anyone in the business world.
• When you understand the fundamentals of accounting, you’re more likely to understand your financial health.

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What Is a Debit?

“Debit” is a term used to describe an accounting transaction that increases an asset or decreases a liability on your balance sheet. You’re probably already familiar with the idea from your debit card. The concept here is similar; a debit can also show an increase in expenses on your profit and loss statement. 

The term “debit” is used to describe a set of transactions in accounting. You may be familiar with the term debit, thanks to your debit card. The concept is similar, which is why almost every financial institution adopted it.

Having a balance sheet makes it easy to keep track of your debits and credits, so you can see outgoing and incoming cash flow. Every debit transaction should have a credit transaction to balance the books. Please note that credits balance debits.

What to Include on Your Balance Sheet

The balance sheet is a statement of a company’s financial position at a given point in time. Assets are recorded on the left side and grouped into three categories: Current Assets, Fixed Assets, and Non-Current Assets.

Liabilities are also recorded on the balance sheet. These get broken down into Current Liabilities and Long-Term Liabilities.

The third section of the balance sheet is Equity, which includes Owners’ Equity (also called Shareholders’ Equity), retained earnings, and Non-Controlling Interests.  

Equity is also recorded on the left, and it’s made up of Owners’ Equity (also called Shareholders’ Equity) plus Non-Controlling Interests.

Debits Are Fundamental to Double-Entry Accounting

Debits are primarily used in double-entry accounting, a system that requires two entries for every transaction. In a standard double-entry journal, debits are typically placed at the top of the journal entry. Corresponding credits are then placed on the line below the debits.

If an accountant is using T-accounts, debits are instead placed on the left while credits are placed on the right. 

Then, all corresponding credits get placed on the line below debits. If an accountant is using T-accounts, then debits get placed on the left, and credits get placed on the right.

For example, let’s say your business takes out a loan to buy new machinery. The company would apply a debit to their fixed assets and a credit to a liabilities account. Sometimes, when reviewing accounting records, you’ll see debit abbreviated as “dr.” This abbreviation stands for “debtor.”

Debits Are Necessary for Trial Balances

Double-entry accounting requires that businesses balance their books. Accountants will often perform trial balances to ensure that all credits and debits are even. All entries have to balance, and in order to do so, the debits must equal the credits. This is also known as zeroing the accounts.

Sometimes, though, the trial balances don’t reach zero. You may find a debit that has no credits to bring it to zero, allowing it to get written off. This is a dangling debit. This can reflect a couple of things: 

• A discrepancy in the company’s balance sheet or income and loss statement that needs investigated
• When a company purchases goodwill or services that create a debit

The Difference Between Account Balances and Debits

In the world of accounting, assets and expenses have debit balances in certain kinds of accounts. This means that when the balances increase, these accounts get debited. Any decrease in the account balances are then credited.

When a company receives any amount of money, it creates a journal entry. If a business receives $500 in cash, a journal entry for it would include a debit to the cash account. This is because the cash account is increasing in value.

Asset and expense accounts are not the only accounts a business carries. They also carry liability, revenue, and equity accounts. On these accounts, debit transactions act the opposite way. Instead of increasing their value, debits reduce their value.

So if an account has a debit on an accounts payable entry, it means that the amount owed is being reduced. At the same time, a credit gets applied to the cash account. This is because a reduction of liability has occurred. Remember, credits reduce the value of asset accounts, like the cash account.

At the end of an accounting period, there will be many debit and credit transactions in an account. The sum of these changes is recorded as the balance on the financial statement.

Offsetting Credits and Debits Is Crucial to Double-Entry Accounting

The ability to offset credits and debits is fundamental to double-entry accounting. Most businesses participate in this style of accounting, which is why a thorough understanding of debits and credits is key to running your business.

Why Double-Entry Accounting Is the Best Accounting Model for Your Business

Double-entry accounting is the process of recording financial transactions. These transactions are summarized in your company’s accounting records.That way, you can see the full value of each transaction instead of getting bogged down in the individual components that changed during the period. It’s a method of accounting that improves transparency and accountability.

Double-entry accounting is an extremely efficient method of recording financial transactions. It requires that each transaction is reported in two different accounts, once as a debit and once as a credit. This ensures that your company’s financial records always remain balanced. 

Moreover, double-entry accounting is useful for managing your company’s cash flow. When cash gets received, it’s recorded on both sides of the ledger. This means that you can have a good idea of how you earn cash and what you spend it on.

Why Use Double-Entry Accounting?

Double-entry accounting is a system of record-keeping. It’s used in most businesses that produce financial statements. If you’re new to double-entry accounting, the following benefits will help clue you in on why it’s so crucial.

Double-entry accounting is typically used in conjunction with bookkeeping, and both are essential for any company with an accounting system. At a high level, double-entry accounting is a method of recording transactions in a company’s accounting system.

Each transaction gets recorded twice, once as a debit and once as a credit. Double-entry accounting is a way of making sure that every piece of business in the company gets accounted for. Many CPAs agree that double-entry accounting is imperative in businesses. Especially ones that have to keep track of several financial transactions.

That’s why professionals use FreshBooks. This powerful tool features Double-Entry Accounting to help you stay on track with debit transactions and more. You also get Expense Tracking to assist you in managing your debit transactions.

What are some other reasons double-entry accounting is important for your business? It can help you keep track of your cash flow and identify any financial irregularities you might have. Let’s take a look at the top four benefits of double-entry accounting.

• It Can Help You Monitor Cash Flow
• It Can Help Ensure Financial Integrity
• It Can Prevent Fraud
• It Can Enhance Operations with Better Reporting

What Is a Debit Transaction?

The term “debit transaction” refers to the act of using a debit card to make a payment. This type of payment does not carry the risk of carrying a credit card balance. This is because a credit card transaction involves the use of cash that is put back into the business’s account.

A debit transaction, however, is an electronic transfer that goes directly from the cardholder’s account to the business’s account.

Why Conduct Debit Transactions?

The rise of online commerce and mobile shopping means that more and more customers are using debit cards to make purchases. Business owners who accept debit card payments in their stores have a lot of advantages compared to those who don’t.

By accepting credit card transactions, businesses are able to bypass the verification process. That means they can accept card payments without additional costs.

Except for the merchant fees, accepting credit card transactions is the same as accepting debit cards. That means customers can pay via debit or credit card transactions, whichever is more convenient for your customers.

When businesses accept debit cards, it means they are able to take payments from debit cards. That means customers only need to present their cards to make payments to the business. In some instances, the merchant may request the customer to enter their card’s PIN. 

The main benefit of accepting debit cards is that it’s much easier for customers to pay for your business with a debit card than with a credit card. Let’s look at the advantages of accepting debit cards for business owners.

• It’s Easy for Customers to Pay
• It’s Secure
• It Shows You’re Authorized for Payments
• It Helps Build Brand Trust

How to Accept Debit Card Payments in Your Business

It’s important to inform customers about how to pay with a debit card. Customers need to know that they can use their debit cards to make the payment.

You can display a sign in your store that informs customers about how to pay with a debit card. You can also put the sign in an area where customers can see it easily. You can also inform your online store about the payment methods you accept.

Another important step is to inform your payment processor that you want to accept debit card payments. You can do this when you sign up for merchant services.

Debit Notes and How They Work

Another thing to understand in relation to debits is debit notes. Debit notes occur in the accounting process when businesses interact with one another. Business to business, or B2B, dealings often happen in business. When one business interacts with another and creates a legitimate debit entry, debit notes get created as a form of proof.

In reality, debit notes are very similar to invoices. They are a result of goods or services provided. The main difference between the two is easy to understand, though. An invoice always shows a sale. Debit notes and debit receipts don’t always reflect a sale.

Instead, they represent adjustments or returns on transactions that have already taken place. This makes them a corrective journal entry, as they aim to fix mistakes. Mistakes may have occurred in a sales, purchase, or loan invoice. If so, the firm issues a debit note. Often, debit notes get issued as a result of a received credit note.

Debits and Bookkeeping Accounts 

In bookkeeping, entries get recorded for every credit and debit transaction that occurs. Every transaction requires two or more entries. This is the basis of double-entry bookkeeping. In this form of bookkeeping, all debit card transactions get separated and applied to various accounts.

For the most part, there are five common accounts that every business uses. We’ve covered them briefly, but let’s look at them more in-depth and how they’re affected by debits and credits.

Assets

Assets are resources that a business owns that can be quickly turned into cash. These can include land, equipment, cash, and vehicles. Assets are increased by debits and decreased by credits.

Liabilities

When a business owes another business or an individual money, it’s considered a liability. A great example of a liability is accounts payable. Debits decrease liabilities, while credits increase them.

Equity

Equity is a measure of what your business is worth. You determine this by subtracting the value of your liabilities from the worth of your assets. Like liabilities, debits decrease equity, and credits increase it.

Expenses

Anything that costs a business money during operations is an expense. Some common examples of expenses a business might incur are wages and supplies. Expenses are increased by debits and decreased by credits.

Revenue

Revenue represents the money that your business is making from sales. It’s also known as your business’s income. Revenue gets decreased by debits, and increased by credits.

Again, it’s important to note that double-entry bookkeeping requires a debit and a credit for every transaction. These entries offset one another and help the books stay in balance with one another.

How Debits Work with Investing

On occasion, investors will do what’s known as “buying on margin.” When an investor does this, it means that they are borrowing funds from their brokerage to add to their own funds. When the funds get combined, they’re able to buy a greater number of shares than they could have alone. This is a great way to be able to invest more when you notice an opportunity.

When this happens, the brokerage records a debit amount in the investor’s account. This debit amount is representative of an increase in the investor’s assets (their cash). This lets the brokerage keep track of the cash they loaned to the investor and what it will cost them. Loans don’t come for free, after all.

In a margin account, the debit amount listed is the amount of money the investor owes to the broker. These funds get advanced to the investor by the broker to allow them to purchase securities.

The debit amount is how much money the investor has to put in their margin account to be able to purchase the shares. The margin account is only debited if the purchase of the shares occurs successfully, however.

After the debit balance gets posted, it can be offset using a credit balance. Long margin accounts only show a debit balance. When a margin account only has short positions, though, it will show a credit balance as well. The credit balance represents the money made from a short sale.

Occasionally, a trader’s margin account will have both long and short positions. If that’s the case, an adjusted debit balance is present in the account. It represents the money that’s owed to the brokerage, minus the profits on short sales and balances in a special miscellaneous account. This is also known as an SMA.

Debits, Credits, and Banking Cards

Debit and credit card transactions relate to accounting transactions of the same name. When looking at them, a debit card and a credit card look nearly identical. However, they represent different accounts. This is the reason that each has a different name.

Debit Cards

When debit cards get used to make a transaction, they negatively impact the cardholder’s account. Each purchase creates a debit transaction with the associated account. Let’s think about the five common accounts and then apply them to the cardholder and payment recipient.

The debit card payment is taking money from the cardholder. It is adding the same amount to the payment recipient’s account. This is the basis of double-entry accounting. For one action, there is another that balances the transaction.

In this case, a debit is being applied to the customer’s equity. At the same time, a credit gets applied to the business’s revenue.

Credit Cards

In the same context, credit card transactions work a little differently. This is because the cardholder’s account isn’t their own money. Instead, it is money that is being borrowed from the card issuers. When a credit card gets used to make a payment, there is a different sequence that takes place.

A customer makes a purchase using a credit card. The balance of their credit card increases. So does the business’s revenue. A debit transaction still takes place. However, instead of applying a debit to the customer’s equity, it gets applied to their expenses. Debits drive expenses up. The business still receives a credit to its revenue.

At this point in time, we have the ability to transfer funds in a number of different ways. For the most part, though, debit cards tend to act like credit card transactions. This is because we are purchasing more things by electronic means. When this happens, it takes a few business days for things to process.

Summary

Debits and debit transactions are an essential part of running a modern business. By understanding their intricacies, you can get a better handle on your company’s finances. And you can ensure that you are managing your finances correctly with the help of double-entry accounting.