Understanding Debits and Credits in Accounting

Key Concept: ADE LER

• ADE LER is a mnemonic to help remember the relationship between debits and credits in accounting.
• Debits are on the left (normal balance), Credits are on the right.

Components of ADE LER

Debit Side (ADE)

1. Assets

   • Normal balance: Debit
   • Increases: Record more debits
   • Decreases: Record credits

2. Dividends (or Drawings)

   • Assets decrease when dividends are paid.

3. Expenses

   • Normal balance: Debit
   • Increases: Record more debits
   • Decreases: Not mentioned in transcript.

Credit Side (LER)

1. Liabilities

   • Normal balance: Credit
   • Increases: Record more credits
   • Decreases: Record debits

2. Equity

   • Also considered as shareholders’ capital.
   • Normal balance: Credit

3. Revenue

   • Normal balance: Credit
   • Increases: When revenue is earned, equity increases.
   • Decreases: Not mentioned in transcript.

Accounting Equation

• The foundation of understanding debits and credits is the accounting equation:
  • Assets = Liabilities + Equity
• Sometimes referred to as the balance sheet equation.
• Assets are what a company owns (e.g., inventory).

Examples of Assets and Liabilities

• Asset Example: Inventory

  • Opening balance: 100 (Debit)
  • Received more inventory: 50 (Debit, increases balance)
  • Shipped product: 30 (Credit, decreases balance)
  • New balance: 120 (Debit)

• Liability Example: Accounts Payable

  • Opening balance: 200 (Credit)
  • Received new invoices: 50 (Credit, increases balance)
  • Made payments: 70 (Debit, decreases balance)
  • New balance: 180 (Credit)

Connecting Debits and Credits

• Transaction Example: When inventory is received and invoiced:
  • Journal Entry: Debit Inventory 50, Credit Accounts Payable 50
  • Total debits equal total credits for each transaction.

Understanding Revenue and Expenses

• Revenue:

  • Normal balance: Credit
  • Increases equity when earned.

• Expenses:

  • Normal balance: Debit
  • Decreases equity when incurred.

Profit and Loss Impact on Equity

• If Revenues > Expenses: Profit, equity increases.
• If Revenues < Expenses: Loss, equity decreases.
• Dividends: Can be paid out of profits, reducing equity.

Conclusion

• DC ADE LER: Remember it, understand it!
• Critical for mastering the fundamentals of accounting.