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Debits and Credits Fully Explained

Credits and Debits and how They Affect Financial Reports

Understanding what credits and debits are, what they do, and the rules for which they add or subtract is vital to figuring out why accounting data is what it is and how it got that way. Please learn the rules of credits and debits.

Total Office Manager does not use the terms Credit and Debit very often.  We have provided this topic as a reference for those of you who need to know more about this subject.

When you deposit money in the bank, the cashier will tell you “I’ll credit your account.” From that experience, most people assume that cash is a credit, and so credits are good. That is further reinforced when reductions in the accounts are referred to as debits. Besides, if you remove the “i” from debit, you get “debt.” So, debits are bad.

Unfortunately, the conditioning we receive at the bank is causing real confusion in the accounting class. Why? Because in accounting we understand that the bank account is a debit account, and that debts are credit accounts – the opposite of what most people expect.

In fact, debits and credits are neither good nor bad. Each transaction, whether it be a good transaction (deposits), or a bad transaction (bills) has both a debit and an equal credit. That’s why they call it “double-entry accounting.” When the cashier is telling you he or she will “credit your account”, they are also entering a debit for the same amount that they are not telling you about. The same is true for the debits to your account – there is also a credit being made at the same time.

The best way to understand debits and credits is to identify two components of each transaction: 1) what did you get; and, 2) where did it come from. The debit is what you got, and the credit is the source of the item you received. For instance, let’s imagine that you purchase a computer with your credit card. Since the computer is what you received it’s going to result in a debit to the asset account for your computer. The credit will be applied to the credit card liability account for the same amount.

The banks tend to confuse us because they are telling us the entry to their liability account. When you deposit money in the bank, their liability to you increases. Since liabilities are credit accounts, they are crediting our account. When they reduce their liability to us, they are debiting their liability account.

Rules for Applying Credits and Debits

  • To increase an asset account, debit it
  • To decrease an asset account, credit it
  • To increase a liability or equity account, credit it.
  • To decrease a liability or equity account, debit it.
  • To record expenses, debit an expense account.
  • To increase Accumulated Depreciation, credit it.
  • There is no exception to the rule that debits must equal credits Debit is often abbreviated as “Dr.” and credit as “Cr.”
  • Credits increase income, liability, and fund accounts and reduce asset and expense accounts
  • Debits increase expense and asset accounts and reduce income and liability accounts
  • When recording expense transactions, the word “charge” is often used in place of the word “debit.”
  • A Credit increases sales, income, liability, equity, and accumulated depreciation accounts. Credits decrease expense and asset accounts.
  • A Debit increases expense and asset accounts. A Debit reduces sales, income, liability, equity, and accumulated depreciation accounts.

What is a Contra Account?

An account that offsets another account. A contra-asset account has a credit balance and offsets the debit balance of the corresponding asset. A contra-liability account has a debit balance and offsets the credit balance of the corresponding liability.

Bad Debt is an example of a “contra-account.” The notion that the account is an income account that is expected to hold a balance opposite to what is normally expected, to counteract the balance in another income account. Accumulated Depreciation, used to diminish the value of an asset over time, is another example of a contra-account.

Understanding Debit Balance Accounts and Credit Balance Accounts

You might hear the phrase debit balance account or credit balance account. A debit balance account is one where a debit adds to the balance. Examples include assets and expenses. A credit balance account is one where a credit adds to the balance. Examples include liabilities and income.

Credits and Debits Cheat Sheet

There are just five main account types used in accounting. They are asset, liability, income, expense, and equity. Accountants will often break those main types down into sub-types. Total Office Manager has thirteen account types, but they are sub-types of the five main account types used in accounting.

Journal Entry Debit and Credit Cheat Sheet
Account Type Account Type Name Used in TOM Debits Credits
Asset Accounts Receivable Increases Decreases
Asset Bank Increases Decreases
Asset Fixed Asset Increases Decreases
Asset Other Asset Increases Decreases
Asset Other Current Asset Increases Decreases
Equity Equity Decreases Increases
Expense Cost of Goods Sold Increases Decreases
Expense Expense Increases Decreases
Expense Other Expense Increases Decreases
Income Income Decreases Increases
Income Other Income Decreases Increases
Liability Accounts Payable Decreases Increases
Liability Credit Card Decreases Increases
Liability Long-Term Liability Decreases Increases
Liability Other Current Liability Decreases Increases
Quick Tip: Debit all expenses and losses and credit all income and gains. Another way to say it is, debit what comes in and credit what goes out.

Tips on Credits and Debits

  1. Recall that there are several types of COA (Chart of Accounts). COAs are used to keep track of where to place currency in the GJ (General Ledger). They are Income, Expense, Asset, Liability, and Equity. There are others but they are sub-types of these. For example, Cost of Goods Sold (COGS) is really just an Expense type. COGS is a way of further defining it. When you are looking for the source of currency, understanding COA types and what they mean is essential.
  2. Debit all expenses and losses and credit all income and gains. Another way to say it is, debit what comes in and credit what goes out.

Related Help Topics

Accounting for Sales Discounts


Accounting for Sales Discounts

How to use Sales Discounts in Accounting

This article offers an overview of discounts and terms (financial terms of the sale). We don’t explain the details of how to setup discounts or terms. There are links at the bottom of this article for that.

Terms and Discounts

There are mainly three types of discounts to manage in accounting.

  1. The discounts you offer customers on a sale.

  2. Discounts you offer customers when they pay early or perhaps within terms, these are called payment terms.

  3. Discounts you receive when paying your vendors early or within terms, these are also called payment terms.

Payment Terms are setup for either customers or vendors. You can setup as many terms as you may need. When you setup terms, you use the same form for both vendor terms and customer terms.

Sales Discounts

When you offer a customer a discount, say 10% for being a senior citizen, you create a discount item. This is a regular item but the item type is a discount. The account (from the Chart of Accounts) is usually the type “Income”. That may seem counter intuitive but your discounts should decrease revenue (AKA: Sales). Otherwise discounts will make your income (sales) too high.

A/R Discounts

Accounts receivable discounts are those you may offer a customer if they pay you within a certain amount of time. This is done to hopefully get your customers to pay you early.

For example you may setup terms that say “1% 10, net 30”. These terms may offer a 1% discount off the sale price if the buyer pays within ten days of the invoice. Otherwise they will owe the entire amount after thirty days.

A\R discounts cost you money and this expense must be tracked. When you setup customer terms, you will be required to pick an account from your COA. We recommend that A\R discounts be treated as a Cost of Goods Sold so you will need to pick an account type of “Cost of Goods Sold”.

A/P Discounts

Accounts payable discounts are those your vendors may offer you if you pay them within a certain amount of time. This is done to hopefully get you to pay them early.

For example, your vendor may offer you terms of “1% 10, net 30”. These terms offer you a 1% discount if you pay your bill within ten days of your purchase. Otherwise you will be required to pay your bill after thirty days.

A\P discounts make you money and this income must be tracked. When you setup vendor terms, you will be required to pick an account from your COA. We recommend that A\P discounts be treated as income so you will need to pick an account type of “Income”.

Tips on Credits and Debits

  • Use the Terms feature to setup terms for both customers and vendors.

  • There are a number of popular terms used by vendors. In fact there is no limit to what vendors may offer you or what you may offer your customers. Another popular term is 1% 10 net 30th. This term offers you a 1% discount if you pay within ten days from the date you made the purchase. Otherwise you owe the entire amount on the thirtieth.

Related Credit and Debit Help Topics

Debits and Credits Fully Explained


Warranty Work and Part Reimbursement Management

How to Handle Warranty Work and Warranty Item Returns

This article discusses how to manage warranty work and how to track and retunes items to the vendor that are covered under their warranty.

In the service industry, warranty work is often a fact of life.  A common scenario might be not long after the installation of a new piece of equipment, maybe an Acme brand air conditioner, a part goes bad and needs to be replaced under warranty.  Your technician makes the repair and keeps the part, tagging it with the information required by the manufacturer.  Back at the shop, you might have up to three options: have the vendor issue a credit to you, have the vendor send you a replacement part, or have the vendor issue you a check for reimbursement.

If the vendor issues a credit to you, simply record the credit in Total Office Manager by going to Vendor > New Credit and using the Vendor Credit form.  This records the credit and makes it available for use in paying future bills received from that vendor.

If the vendor is to send you a replacement part or issue you a reimbursement check, do the following:

  • Setup the vendor with their own customer account.  In our example, Acme Manufacturing would have both vendor and customer accounts in Total Office Manager.
  • Create a new account in your Chart of Accounts, named something like “COGS – Warranty Parts & Labor”.  Be sure to set this account Type to “Cost of Goods Sold”.
  • To perform the next step, an administrator will have to turn off Total Office Manager’s “Smart Account Selection Filtering”.  This is found by clicking Edit > Preferences, and going to the Accounting Defaults tab.  After un-ticking (un-check) the checkbox for Smart Account Selection Filtering, the administrator will have to agree to an important message then enter the administrator password to proceed.  Click the “Close” button to leave the Preferences form.
  • Now create a new Invoice Item by clicking Customers > New Invoice Item.  Call it something like “WarrantyReturn” with a description like “Item returned to vendor under warranty coverage”.  Be sure to set the Type field to Other Charge.  In the Accounting tab, set the Income Account field to the COGS account you just setup to handle warranty work.  Total Office Manager will warn you that the account you’re choosing is not an income account.  Click the “Yes” button to ignore the warning and proceed.
  • Turn the Smart Account Selection Filtering back on by ticking it’s checkbox in the Accounting Defaults tab of Preferences.
  • Create a new invoice and choose the vendor as the customer.  You will “sell” the new Invoice Item you just created for handling warranty work to the vendor.  Enter the value of the warranty reimbursement in the Amount field.
  • If you receive a replacement part from the vendor, go to Customers > Create Credit Memos/Refunds and issue a credit to the vendor for the same amount as the warranty invoice.  Now use this credit to “pay” the vendor’s invoice by clicking Customers > Receive Payments. In the New Payment form, tick the checkbox next to the warranty invoice to pay, then click the “Set Credit” button to select the credit you just created.
  • If you receive a reimbursement check from the vendor, go to Customers > Receive Payments, and use the check to pay the vendor’s invoice, listed in the lower portion of the New Payment form, just as any other received payment.

Using this method of managing warranty work will keep track of any reimbursement amounts due to you from your vendors as a receivable until the vendors “payoff” that receivable account with either a credit issued from sending you a replacement part, or with an ordinary reimbursement check.  The complete transaction becomes a “wash” having no net effect on your income or related tax liabilities.

Warranty FAQ


Sometimes when I do work at a client location, I may have to replace a part that is still under warranty. The warranty covers part of the job (usually the material and not the labor). I removed the replacement part from my current inventory, but the Manufacturer needs to repay me for that item. How do I handle this?


You would receive your serialized item into stock as usual. When you go out to the customer’s location you would replace the item with a new Serialized Item and Invoice the Customer for the full price of the item.

You would also create a Credit Memo for the customer returning the original serialized item to them for credit. This credit memo would then be applied to the new invoice, therefore making only the labor portion due on the invoice.

You would then create a Vendor Credit for the Item that the Vendor needs to pay for. You would choose the serialized Item that was returned from the customer and the serial #.

If the Vendor sends a replacement item, you would enter a bill for the item entering the replacement serial number to put into stock. You would then apply the Vendor Credit to the new Bill.

If the Vendor does not send a replacement item, you would then apply the Vendor Credit to any open Bill for the Vendor.


We sell equipment to a customer, and we perform labor that needs to be billed to the customer. Then a problem occurs with the equipment we sold the customer and it’s still under warranty by the vendor. We need to be able to return this equipment for replacement.


You would have already received the equipment into stock because it was already sold to the customer. When you sold the equipment to the customer you included the serialized item on the invoice and charged the customer for labor. If the customer is only charged for labor and a discount is used then their invoice total would reflect labor only. Once the equipment is deemed faulty you need to return it to the vendor as it is under warranty. To do so in the system, you would then create a customer credit. You may do so by going to the original invoice, edit the invoice, go to menu; create; credit memo. You will receive a message asking you to create a credit for the entire amount of the invoice, go ahead and click yes. The credit will appear on your screen and you will see the credit is for both the serialized equipment and the labor. Delete the line entry for labor because we still want to charge this to the customer. If a discount was used on the invoice to discount off the equipment price, you will enter in a retail price of zero for the serialized equipment so we can properly but the equipment back into stock (to later be returned to the vendor) and have a credit with no balance. If the equipment was sold to the customer at full price, you will make sure this price is reflected on the credit. This will create a credit for the customer which will need to be applied to the customer’s invoice.

The credit amount will be the exact amount of the equipment and the invoice will be the equipment plus the labor. You will do a receive payment for that customer to apply the credit to the invoice, leaving a balance on the invoice for just the labor. (Again, this is only if the equipment was not discounted on the customer’s original invoice).

Your next step is to create the vendor credit for the vendor who covers the equipment sold. Because you have created a customer credit putting that serialized item back into stock, you can now select that item on the vendor credit to return to the vendor as faulty equipment. If the vendor sends a replacement piece of equipment, you will receive that equipment into stock and enter a bill for that vendor with the new serial number. Once the bill is entered you can apply the vendor credit to the vendor bill leaving a $0 balance on both.

You will then need to create a new invoice for the customer selling the new piece of equipment back to them. If you did not discount the equipment on the first invoice and applied the customer’s credit to their first invoice, you will need to discount off this equipment as it is a replacement to them they are not responsible for paying. You can either use a discount invoice item on the invoice, or you can do a receive payment and in the invoice line item on the receive payment, select the discount account, date and amount.

Content Related Warranty Management

Creating and Using a Warranty Reserve – All-In-One Field Service Management Software by Aptora

Entering Credits – Vendor Credit List | Aptora



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