Debit and Credit

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 basis of credit.

In this context, we will delve deep into the discussion of debit and credit in accounting, know its effect in the accounting transaction of a business, know the rules engaging debit and credit, journal entries in effect to it.

Debit and Credit in Accounting

Debit and Credit are the two accounting tools. Business transactions are to be recorded and hence, two accounts, which are debit and credit, get 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, come into 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 debt 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-

• Assets

• Expenses

• Liabilities

• Equity

• Revenue

Different Effects of Debit and Credit are as Follows

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.

Difference between Debit and Credit

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 of this expense account.

Given below is a comparison chart to have a thorough understanding of the difference between the concept of debit and credit.

Rules for 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 the 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 transactions 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 are to be recorded in the machinery account and cash account respectively. This recording will also be detailed in the ledger account.

On which side does 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 debited. 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 credited. To increase the account, we will record it on the credit side, and to decrease the account, we will record it on the debit side.

It only follows the opposing force or the vice versa factor.

A level-up concept, Contra Accounts, is only the opposite of the relevant accounts. The normal balance can be both debit or credit. Here, to neutralize this, a contra account is used. To recall, the utmost rule of debit and credit is that total debits equal total credit which applies to all the totaled accounts.

Accounting Journal Entries

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 of Rs. 50,000

Bank A/C..........Dr. 50,000

To Capital A/C 50,000

2. Bought goods from Rita for Rs. 800

Purchase A/C.....Dr. 800

To Rita 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.

Debit and Credit Examples

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.

Examples-

The following transactions are related to a trading business:

1. Started business with cash Rs. 1,50,000.

• Accounts involved - A cash account and a 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 - The asset account will increase and the 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 the expense account and decrease in the cash account.

To wrap up the two sides, Debit and Credit indicate destination and source respectively.

The Source of monetary benefit is credited and the destination account is debited. The concept of debit and credit is much of interest to an accounting student as it is the base for overall commerce study.

Example of Debit and Credit

The following transactions are related to ABC Traders:

• Started business with cash Rs. 1,00,000.

• Purchased goods for cash Rs. 50,000.

• Purchased furniture for cash Rs. 30,000.

• Purchased goods on credit worth Rs. 80,000.

• Sold goods for cash Rs. 20,000.

• Sold goods on credit worth Rs. 30,000 to Vikram traders.

• Paid salaries to employees - Rs. 15,000.

Solved Example

Pass the journal entries for the following:

Cash brought by the owner - Rs. 1,00,000

Rent paid - Rs. 10,000

Repayment of loan - Rs. 50,000

Ans: The following are the journal entries

Conclusion

In a nutshell, when a financial transaction occurs, it affects two accounts. Debit and credit are two important accounting tools that provide a base for every business transaction. The total of debits should always be equal to the credits. If the debt is not equal to the credit, the accounting transaction will not be in balance. With this, it is difficult to create financial statements. Thus, the use of debits and credits in a two-column recording format is the most essential for the accuracy of accounting records.