The three account types that increase when they are debited and decrease when they are credited are Assets, Expenses, and Dividends (or Drawings/Withdrawals).
Understanding Debits and Credits in Accounting
In the system of double-entry accounting, every financial transaction impacts at least two accounts. Debits are traditionally recorded on the left side of an account, while credits are recorded on the right side. The effect of a debit or credit on an account depends on the account type.
For specific account types, debits increase the balance, and credits decrease it. This fundamental rule is crucial for maintaining balanced accounting records and accurate financial statements.
The Three Account Types
The following account types follow the rule of increasing with a debit and decreasing with a credit:
Assets
Assets represent economic resources owned by a business that are expected to provide future economic benefits. Examples include cash, accounts receivable, inventory, property, plant, and equipment.
- Debit Effect: A debit to an asset account increases its balance. For example, when a company receives cash (an asset), the cash account is debited.
- Credit Effect: A credit to an asset account decreases its balance. For instance, when a company pays out cash, the cash account is credited.
Expenses
Expenses are the costs incurred by a business in its efforts to generate revenue. They represent the outflow of economic benefits during an accounting period. Common examples include rent expense, salary expense, utility expense, and cost of goods sold.
- Debit Effect: A debit to an expense account increases its balance. For example, when a company pays for advertising, the advertising expense account is debited.
- Credit Effect: A credit to an expense account decreases its balance. This is less common in day-to-day operations but occurs, for instance, to correct an over-recorded expense.
Dividends (or Drawings/Withdrawals)
Dividends represent distributions of a company's earnings to its shareholders. In the case of sole proprietorships or partnerships, these are often referred to as owner's drawings or withdrawals, which are funds or assets taken out of the business by the owner(s) for personal use. These accounts are contra-equity accounts, meaning they reduce the owners' equity.
- Debit Effect: A debit to a dividend or drawings account increases the amount of distributed earnings or owner withdrawals.
- Credit Effect: A credit to a dividend or drawings account decreases the amount. This typically happens rarely, often for corrections.
Visualizing Account Behavior
The following table summarizes how debits and credits affect different types of accounts, highlighting their normal balances:
| Account Type | Normal Balance | Debit Effect | Credit Effect |
|---|---|---|---|
| Assets | Debit | Increase | Decrease |
| Expenses | Debit | Increase | Decrease |
| Dividends | Debit | Increase | Decrease |
| Liabilities | Credit | Decrease | Increase |
| Equity | Credit | Decrease | Increase |
| Revenue | Credit | Decrease | Increase |
Note: In traditional double-entry accounting, debits are entered on the left, and credits are entered on the right.
Why This Matters
Understanding which account types increase with debits and decrease with credits is fundamental to accurate bookkeeping and financial reporting. It ensures that transactions are recorded correctly, that the accounting equation (Assets = Liabilities + Equity) remains balanced, and that financial statements accurately reflect the company's financial position and performance. This knowledge is essential for anyone involved in managing business finances, from small business owners to professional accountants.
