Debits and credits

This article is about the bookkeeping concept of debits and credits. Not to be confused with the financial concepts of debt and credit, or with credit cards.

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Debit and credit are formal bookkeeping and accounting terms. They are the most fundamental concepts in accounting, representing the two sides of each individual transaction recorded in any accounting system. A debit indicates an asset or an expense transaction, a credit indicates a transaction that will cause a liability or a gain. A debit transaction can also be used to reduce a credit balance or increase a debit balance. A credit transaction can be used to decrease a debit balance or increase a credit balance. Debit and credit form the basis of the double-entry bookkeeping system. Every debit and credit value are recorded in ledgers and from these ledgers financial reports can then be prepared.

Contents 1 Introduction 2 Origin of the terms debit and credit 3 Operational Principles 4 Debit and Credit principle 4.1 Examples 5 'T' Accounts 6 References 7 External links

[edit] Introduction

Debits and credits are a system of notation used in bookkeeping to determine how and where to record any financial transaction. In bookkeeping, instead of using additions '+' and subtraction '-' symbols, a transaction uses the symbol DR (Debit) or CR (Credit). In double-entry bookkeeping debit is used for asset and expense transactions and credit is used for liability, gain and equity transactions. For bank transactions, money received in is treated as a debit transaction and money paid out is treated as a credit transaction. Traditionally, transactions are recorded in two columns of numbers: debits in the left hand column and credits in the right hand column. Keeping the debits and credits in separate columns allows each to be recorded and totalled independently. Where the total of the debit value amounts is lower than the total of the credit value amounts, a balancing debit value is posted to that nominal ledger account. That nominal ledger account is now "balanced". An account can have either a credit value balance or a debit value balance but not both.

A debit can also be used to reduce the balance on a liability, gain and equity account. This has the effect of reducing a credit balance by the value of the debit transaction. The balance in a nominal that is normally expected to hold a debit balance may change from a debit balance to a credit balance.

A credit can also be used to reduce the balance on an asset or expense account. This has the effect of reducing a debit balance by the value of the credit transaction. The balance in a nominal that is normally expected to hold a credit balance may change from a credit balance to a debit balance.

In some cases such as fixed assets, all debit transactions will be recorded in one nominal account and all credit transactions will be recorded in a contra nominal account, with the exception when an asset is disposed of. The purchase of an asset will be recorded in a fixed asset account (debit transaction) and the depreciation of the fixed asset (credit transaction) will be recorded in a contra nominal ledger account, fixed asset depreciation.

[edit] Origin of the terms debit and credit

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The term debit comes from Middle French debet from Latin debitum "that which is owed" (the neuter past participle of debere "to owe"). Debit is abbreviated to Dr. The term credit comes from the Latin creditum meaning "that which is entrusted or loaned" from the past participle of credere "to trust or entrust". Credit is abbreviated to Cr. The abbreviation Dr. and Cr. should not be confused with the words Debtor and Creditor.

[edit] Operational Principles

Real Accounts

• In real accounts any increment in assets held by the entity is reflected by increasing the relevant asset account and depletion by crediting the asset account.
• If any asset account is debited then it is on account of increment in the value or acquisition of that liability or owner's equity which decreases the resources held by the entity.

As the total resources held by the entity cannot indigenously increment themselves the depletion has to be matched with a fall in resources within the entity.

Personal Accounts

• In Personal Accounts debiting the personal account of any external entity increases the value of the monies receivable from that external entity thus augmenting the resources of the accounting entity.
• Similarly crediting the personal account of any external entity reduces the value of monies receivable from that entity thus reducing the resources of the accounting entity.

Nominal Accounts

• Nominal Accounts are accounts which arise only after commencement of the accounting period and are closed at the end of the accounting period.
• Nominal accounts represent incomes and expenses which accrue during the accounting period and the net result of the total incomes and expenses accruing during the accounting period is absorbed in the profit and loss account as the profit or loss for the accounting period which is then transferred to reserves or shareholders funds or owners equity in accordance to the ownership.
• In Nominal Accounts the Expense accounts whenever debited are done as the Expense incurred represents the Goods and/or Services acquired for consumption by the entity and hence are temporary increments in the resources of the accounting entity.
• In Nominal Accounts the Income accounts are credited as the Income earned is a result of goods or services provided by the accounting entity which is a depletion of the resources of the accounting entity used for earning that income.

Cross-Application over Different Types of Accounts

• The principles apply uniformly to all combinations of accounting entries involving different types of accounts based on varying circumstances.

	Real Account Debited	Personal Account Debited	Nominal Account Debited
Real Account Credited	Acquisition of an Asset in Cash - Machinery Account Debited, Cash Account Credited	Sale of an Asset on Credit - Buyer's Account Debited, Machinery Account Credited	Amortisation or Depreciation of an Asset - Depreciation Account Debited, Machinery Account Credited
Personal Account Credited	Acquisition of an Asset on Credit - Machinery Account Debited, Seller's Account Credited	Transfer of a Debt Receivable to another - New Debtor's Account Debited, Old Debtor's Account Credited	Accrual of Expenditure - Electricity Account Debited, Electricity Company's Account Credited
Nominal Account Credited	Capitalisation of Expenditure - Machinery Account Debited, Research and Development Account Credited	Sale of Goods on Credit - Buyer's Account Debited, Sales Account Credited	Inter head transfer of Expenditure - New Expenditure Head Debited, Old Expenditure Head Credited

Simple Thumb Rules to remember which accounts to credit and which to debit:

Personal accounts: Debit: the receiver; Credit: the giver

Real/Asset Accounts: Debit: what comes in; Credit: what goes out

Nominal/Expense Accounts: Debit: all expenses/losses; Credit: all income/gains

[edit] Debit and Credit principle

Each transaction consists of debits and credits, and for every transaction they must be equal.

For Every Transaction: The Value of Debits = The Value of Credits

The extended accounting equation must also balance: 'A + E = L + OE + R'

(where A = Assets, E = Expenses, L = Liabilities, OE = Owner's Equity and R = Revenues)

So 'Debit Accounts (A + E) = Credit Accounts (L + R + OE)'

Debits are on the left and increase a debit account and decrease a credit account.

Credits are on the right and increase a credit account and decrease a debit account.

[edit] Examples

1. when you pay rent with cash: you increase rent (expense) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.
2. when you receive cash for a sale: you increase cash (asset) by recording a debit transaction, and increase sales (revenue) by recording a credit transaction.
3. when you buy equipment with cash: You increase equipment (asset) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.
4. when you borrow with a cash loan: You increase cash (asset) by recording a debit transaction, and increase loan (liability) by recording a credit transaction.
5. When you pay salary with cash: you increase salary (expenses) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.

	Account	Debit	Credit
1.	Rent	100
	Cash		100
2.	Cash	50
	Sale		50
3.	Equip.	5200
	Cash		5200
4.	Cash	11000
	Loan		11000
5.	Salary	5000
	Cash		5000

[edit] 'T' Accounts

The process of using debits and credits creates a ledger format that resembles the letter 'T'.^[1] The term 'T' account is commonly used when discussing bookkeeping. Debits are placed on the left and credits on the right.

Debits	Credits

TYPE	DEBIT	CREDIT
Asset	+	−
Liability	−	+
Income	−	+
Expense	+	−
Equity	−	+

Therefore, if an Asset account is debited, the Asset amount (value) is increased. Same with an Expense account. If a Liability or an Income account is debited, the numerical figure will decrease, etc. If a particular account is credited, there must be a corresponding Debit in another account in order to balance the transaction.

As used in banking terminology, 'Debits" refer to withdrawals, not necessarily in the same context as discussed here.

[edit] References

[edit] External links

Look up debit or credit in Wiktionary, the free dictionary.

• Debits and Credits