An accounting expression starts with 'Debit' and 'Credit'. You might be wondering what is debit and credit? Also, this is intriguing enough why is it that if we debit some accounts, it makes them go up while when some other sets of accounts get debited, it goes down? More importantly, how is this important for any business?
In a nutshell, recording all the money flowing into the account is the basis of debit while recording all the money flowing out of the account is the base of credit.
Debit and Credit are the two accounting tools. Business transactions are to be recorded and hence, two accounts, which are debit and credit, gets facilitated. These are the events that carry a monetary impact on the financial system. While keeping an account of this transaction, these accounting tools, debit and credit, comes in the play. Whenever accounting transactions take place, it majorly affects these two accounts.
'In balance' is such an accounting transaction where the total of the debit and credit matches or is equal. In contrast, if the debit is not equal to the credit, creating a financial statement will be a problem.
The business transaction is separated into accounts while doing the bookkeeping. The commonly affected accounts are-
In effect, a debit increases an expense account in the income statement and a credit decreases it. Liabilities, revenues and equity accounts have a natural credit balance. If the debit is applied to any of these accounts, the account balance will be decreased.
It is quite amusing that debits and credits are equal yet opposite entries. A debit increases an account. Now to increase that particular account, we simply credit it. However, we use this opposite treatment to get the desired result.
A left-sided entry is headed with debit. It increases an asset or expenses account or decreases equity liability or revenue accounts. For example, ‘Purchase of a new computer’. Here, the asset gained (computer) is to be notified on the left side of the asset account.
Whilst the right side is marked by the credit entry, it either increases equity, liability or revenue accounts or decreases an asset or expense account. In the ‘Purchase of a new computer’, the expense (payment for the computer) is credited on the right side in this expense account.
Given below is a comparison chart to have a thorough understanding of the difference between the concept of debit and credit.
The golden rules of accountancy govern the rule of debit and credit. Before we examine further, we should know the three famous golden rules of accountancy:
First: Debit what comes in and credit what goes out.
Second: Debit all expenses and credit all incomes and gains.
Third: Debit the Receiver, Credit the giver.
To compress, the debit is 'Dr' and credit is 'Cr'. So, a ledger account, also known as a T-account, consists of two sides. As talked about earlier, the right-hand side (Cr) records credit transaction and the left-hand side (Dr) records the debit transaction.
Suppose we purchase machinery for the cash, this transaction will increase the machinery and decrease cash because machinery comes in and cash goes out of the business. Further, this increase in machinery and the decrease in cash is to be recorded in the machinery account and cash account respectively. This recording will also be detailed in the ledger account.
On which side the increase or decrease of the accounts appear? This is answered by studying the 'normal balance of accounts' and 'rules of debit and credit.' Understanding the normal balance will accelerate the learning of the rules.
The normal balance of all assets and expenditures accounts is always debit. We shall record the increment of this account on the debit side. If we need to decrease the account, we will record it on the credit side.
Next, the normal balance of all the liabilities and equity (or capital) accounts is always credit. To increase the account, we will record it on the credit side and to decrease the account, we will record on the debit side.
It only follows the opposing force or the vice versa factor.
A level up concept, Contra Accounts, is only opposite to the relevant accounts. The normal balance can be both debit or credit. Here, to neutralize this, contra account is used. To recall, the utmost rule of debit and credit is the total debits equal total credit which applies to all the totalled accounts.
In an accounting journal entry, we find a company's debit and credit balances. The journal entry consists of several recordings, which either have to be a debit or a credit.
Below is a list of basic five journal entries, we will straight away delve into it-
1. Manav started the business with cash Rs. 50,000
Bank A/C..........Dr. 50,000
To Capital A/C 50,000
2. Bought goods from Ritra Rs. 800
Purchase A/C.....Dr. 800
To Ritra A/C 800
3. Sold goods to Mr Nayak at Rs. 10,000
Mr Nayak A/C.....Dr. 10,000
To Sales A/C 10,000
4. Paid wages Rs. 50
Wages A/C...........Dr. 50
To Bank A/C 50
5. Carriage outwards Rs.60
Carriage Outwards A/C......Dr.60
To bank A/C 60
Be it economic or noneconomic, we keep and make records of any transaction and this is the root meaning of journal entries which is represented above.
This study is incomplete without the citing of examples. For practical application, the hereinafter examples will be worthy to understand the basal of debit and credit.
The following transactions are related to a trading business:
1. Started business with cash Rs. 1,50,000.
Accounts involved - A cash account and Capital account
Nature of the account - Asset and Equity
Increase/Decrease - Both will increase
2. Furniture purchased for cash Rs. 10,000
Accounts involved- Furniture account and cash account
Nature of the account- Asset and Asset
Increase/Decrease - Asset account will increase and cash account will decrease
3. Purchased goods for cash Rs. 1000
Accounts Involved - Purchase account and cash account.
Nature of the account- Expense and Asset.
Increase/Decrease- Increase in expense account and decrease in the cash account.
To wrap up the two sides, Debit and Credit indicates destination and source respectively.
Source of monetary benefit is credited and the destination account is debited. Concept of debit and credit is much of an interest for an accounting student as it is the base for overall commerce study.
1. What is the Debit and Credit Formula?
Asset = Equity + Liability. Increase in the asset is debited and the decrease in the asset is credited while the increase in liability is credited and the decrease in liability is debited. Whether a debit increase or decreases, an account depends on what kind of account it is. In the accounting equation: Assets = Liabilities + Equity
If an asset account increases (by a debit), then one must also either decrease (credit) another asset account or increase (credit) a liability or equity account.
2. Is Debit Plus or Minus?
Debit is left and credit is right. Not to associate with plus or minus.
Debit simply means left and credit means right. ‘Debit’ is a formal bookkeeping and accounting term that comes from the Latin word ‘Debris’, which means ‘to owe’. The debit falls on the positive side of a balance sheet account and the negative side of a result item.
3. What Do DR and CR Stand for?
DR and CR stand for Debit Record and Credit Record respectively. When it comes to the DR and CR abbreviations for debit and credit, some believe that DR notation is short for debtor and CR is short for the creditor.