1. Debits, Credits, & The
Relationship between the
Income Statement & the
Balance Sheet
Your Basic Financial Accounting Guide
by
Dr. Tanae W. Acolatse

2. Rules of Debits & Credits: Graphic
Normal Balances of Accounts
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Source: Warren, C.S. (2012). Survey of Accounting (6th ed). Mason, OH: South Western, Cengage Learning

3. Rules of Debits & Credits
Normal Balances of Accounts
O The normal balance of an account is the side
of the account used to record increases
O The normal balance of an asset account is a
debit balance, while the normal balance of a
liability account is a credit balance
O Useful in detecting errors in the recording
process.
 If an account normally having a debit balance
actually has a credit balance, or vice versa, an
error has occurred or an unusual situation
exists.
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4. Asset Accounts
Asset Accounts: Increased by debits and have a normal
debit balance (on the left side of the accounting equation)
O Exception: Some asset accounts, called contra asset
accounts, are increased by credits and have normal credit
balances.
O As the words contra asset imply, these accounts offset the
normal debit balances of asset accounts
Example: Accumulated depreciation, an offset to plant assets,
is increased by credits and has a normal credit balance.
Thus, accumulated depreciation is a contra asset account
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5. Liability & Stockholders’
Equity Accounts
O Liability and stockholders' equity
accounts (on the right side of the
accounting equation)
O Increased by credits and have
normal credit balances
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6. Dividend Accounts
O Dividend accounts appear on the
right side of the accounting equation
and decrease stockholders' equity
(retained earnings)
O Increased by debits and have a
normal debit balance
O Can be thought of as a type of
contra account to retained earnings
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7. Revenue Accounts
O Revenue accounts appear on the
right side of the accounting
equation and increase
stockholders' equity (retained
earnings)
O Increased by credits and have
normal credit balances
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8. Expense Accounts
O Expense accounts appear on the
right side of the accounting equation
and decrease stockholders' equity
(retained earnings)
O Increased by debits and have a
normal debit balance
O Can be thought of as a type of
contra account to revenues
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9. Summary
O The rules of debit and credit require that for each transaction, the
total debits equal the total credits
O Each transaction must be recorded so that the total debits for the
transaction equal the total credits.
Example: Assume that a company pays cash of $500 for supplies.
Asset Account: Supplies is debited (increased) by $500
Asset Account: Cash is credited (decreased) by $500
Example: If the company provides services and receives $2,000
from customers
Asset Account: Cash is debited (increased) by $2,000
Revenue Account: Fees Earned is credited (increased) by $2,000
transactions. 9

10. Relationship Between Accounts
10Source: Tracy, J. A. (n.d.) Connecting the Income Statement and Balance Sheet. Retrieved from http://www.dummies.com/how-
to/content/connecting-the-income-statement-and-balance-sheet.html

11. Relationship Between Accounts
(continued)
Accounts are connected as follows beginning with Sales:
O Making sales (and incurring expenses for making sales)
requires a business to maintain a working cash balance.
O Making sales on credit generates accounts receivable.
O Selling products requires the business to carry an
inventory (stock) of products.
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12. Relationship Between Accounts
(continued)
O Acquiring products involves purchases on credit that
generate accounts payable.
O Depreciation expense is recorded for the use of fixed
assets (long-term operating resources).
O Depreciation is recorded in the accumulated
depreciation contra account (instead decreasing the
fixed asset account).
O Amortization expense is recorded for limited-life
intangible assets.
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13. Relationship Between Accounts
(continued)
O Operating expenses is a broad category of costs
encompassing selling, administrative, and general
expenses:
O Some of these operating costs are prepaid before the
expense is recorded, and until the expense is
recorded, the cost stays in the prepaid expenses
asset account.
O Some of these operating costs involve purchases on
credit that generate accounts payable.
O Some of these operating costs are from recording
unpaid expenses in the accrued expenses payable
liability. 13

14. Relationship Between Accounts
O Borrowing money on notes payable
causes interest expense.
O A portion (usually relatively small) of
income tax expense for the year is unpaid
at year-end, which is recorded in the
accrued expenses payable liability.
O Earning net income increases retained
earnings.
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15. References
Tracy, J. A. (n.d.). Connecting the income
statement and balance sheet. Retrieved
from http://www.dummies.com/how-
to/content/connecting-the-income-
statement-and-balance-sheet.html.
Warren, C.S. (2012). Survey of Accounting
(6th ed). Mason, OH: South Western,
Cengage Learning.
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