(Accounting) Debit & Credit

 

Example:

Prepaid Expenses:

Example 1: Prepaid Rent

Suppose a company pays three months' rent in advance. The journal entry would be:

 

1.At the time of payment:

·        Debit: Prepaid Rent (Asset, increases)

·        Credit: Cash (Asset, decreases)

Explanation: The company has paid for future rent, so it records it as an asset (prepaid rent).

 

2.When each month passes (Adjustment):

·        Debit: Rent Expense (Expense, increases)

·        Credit: Prepaid Rent (Asset, decreases)

Explanation: As each month passes, part of the prepaid rent becomes an expense.

 

Example 2: Prepaid Insurance

Let's say a company pays an annual insurance premium in advance:

 

1.At the time of payment:

·        Debit: Prepaid Insurance (Asset, increases)

·        Credit: Cash (Asset, decreases)

Explanation: The company prepays for insurance, recognizing it as an asset.

 

2.Monthly Adjustment:

·        Debit: Insurance Expense (Expense, increases)

·        Credit: Prepaid Insurance (Asset, decreases)

Explanation: Monthly, a portion of the prepaid insurance becomes an expense.

Accrued Expenses:

Example 1: Accrued Salaries

Suppose at the end of the month, employees have worked, but payday is not until the next month:

 

1.End of the Month Adjustment:

·        Debit: Salary Expense (Expense, increases)

·        Credit: Accrued Salaries (Liability, increases)

Explanation: The company recognizes the expense incurred but not yet paid as an accrued liability.

 

2.When Salaries are Paid:

·        Debit: Accrued Salaries (Liability, decreases)

·        Credit: Cash (Asset, decreases)

Explanation: When salaries are paid, the accrued liability is reduced, and cash is decreased.

 

Example 2: Accrued Utilities

Imagine the company uses utilities throughout the month but is billed at the start of the next month:

 

1.End of the Month Adjustment:

·        Debit: Utilities Expense (Expense, increases)

·        Credit: Accrued Utilities (Liability, increases)

Explanation: The company recognizes the expense for utilities used but not yet billed.

2.When Utilities are Paid:

·        Debit: Accrued Utilities (Liability, decreases)

·        Credit: Cash (Asset, decreases)

Explanation: When the utility bill is paid, the accrued liability is reduced, and cash is decreased.

 

Advance Payment (Unearned Revenue):

Example: Customer Advance Payment for Services

 

1.At the time of receiving advance payment:

Debit: Cash (Asset, increases)

Credit: Unearned Revenue (Liability, increases)

Explanation: The company receives cash in advance but has not yet earned the revenue, so it records the unearned revenue as a liability.

 

2.When services are provided (Revenue is Earned):

Debit: Unearned Revenue (Liability, decreases)

Credit: Service Revenue (Revenue, increases)

Explanation: As the company provides the services, it recognizes the revenue, and the unearned revenue liability decreases.

 

Accrued Revenue:

Example: Services Provided but Not Yet Billed

 

1.At the time of providing services:

Debit: Accounts Receivable (Asset, increases)

Credit: Service Revenue (Revenue, increases)

Explanation: The company provides services but has not yet billed the customer, recognizing the revenue and creating an accounts receivable.

 

2.When the invoice is issued:

Debit: Cash (Asset, increases) or Accounts Receivable (Asset, decreases)

Credit: Service Revenue (Revenue, increases)

Explanation: When the customer pays or is billed, the accounts receivable is reduced, and cash is increased.