When recording transactions in the accounting records, the accountant and bookkeeper use the terms debit and credit. The amount in every transaction must be entered in one account as a debit (left side of the account) and in another account as a credit (right side of the account). This double-entry system provides accuracy in the accounting records and financial statements.
What is a Debit?
A debit is an accounting entry that either increases an asset or expense account or decreases a liability or equity account. It is positioned to the left in an accounting entry. A debit may be indicated in journal entries with the abbreviation “dr.” The reverse of a debit is a credit.
What is a Credit?
A credit is an accounting entry that either increases a liability or equity account or decreases an asset or expense account. It is positioned to the right in an accounting entry. A credit is recorded on the right side of a T account.
Use of Debit and Credit.
A double accounting entry system records an accounting transaction in two accounts. One account is debited and another account is credited. There is no upper limit to the number of accounts involved in a transaction - but the minimum is no less than two accounts. The totals of the debits and credits for any transaction must always equal each other. If a transaction were not balanced, it would be impossible to create financial statements. Thus, the use of debits and credits in a two-column transaction recording format is the most essential of all controls over accounting accuracy.
What is Account?
To keep organized financial data of a company, accountants developed a system that sorts transactions into records called accounts. When a company's accounting system is set up, the accounts most likely to be affected by the company's transactions are identified and listed. This list is referred to as the company's chart of accounts. Depending on the size of a company and the complexity of its business operations, the chart of accounts may list as few as thirty accounts or as many as thousands. A company can tailor its chart of accounts to meet its needs best.
Debit and Credit Rules
The rules governing the use of debit and credit are set out below.
Changes to Debit Balance
Generally in accounts that have a debit balance, when the amount is added to the debit balance (column on the left), the amount in the account also increases. Similarly, when an amount is added to the credit balance of that account, the amount in that account decreases. Accounts to which this rule applies such as expenses, assets, and dividends.
Changes to Credit Balance
Generally in accounts that have a credit balance, when the amount is added to the credit balance (column on the right), the amount in the account also increases. Similarly, when an amount is added to the debit balance of that account, the amount in that account decreases. Accounts to which this rule applies such as liabilities, revenues, and equity.
Total Must Match
The total amount of debits must equal the total amount of credits in a transaction. Otherwise, an accounting transaction is said to be unbalanced, and will not be accepted by the accounting software.
Debits and Credits in Common Accounting Transactions
The following bullet points note the use of debits and credits in the more common business transactions:
- Cash Sales: Cash Account will be Debit | Sales Account (Revenue Account) will be Credit. (In the above point the cash is a Real Account, So the "debit what comes in" rule will be applied. Sales Or Revenue Account is a Nominal Account, So the "All Profits and Incomes are Credit" Rule will be used.)
- Credit Sales: Debtors Account (Account Receivable) will be Debit | Sales Account (Revenue Account) Will be credited. ( In the above point the Debtor A/c is Personal Account related to the Person, So the "Debit the receiver" Rule will be applied. Sales Or Revenue Account is a Nominal Account, So the "All Profits and Incomes are Credit" Rule will be used.)
- Received cash in payments of accounts receivable: Cash Account will be Debit| Account Receivable Account will be credited. (In the above point the cash is a Real Account, So the "Debit what comes in" rule will be applied. Account receivable is a personal Account, So the " Credit the giver " Rule will be applied.)
- Purchase supplies from supplier for cash: Supplies Expenses Account will be Debit| Cash Account will be Credit. (In the above point the Supplies Expenses Account is Nominal Account, So the " All Income and Expenses Account Debit" Rule will be applied. Cash is a Real Account so the "Credit what goes out" Rule will be applied.
- Purchase supplies from suppliers for credit: Supplies Expenses Account will be Debit | Account Payable Or Creditor Account will be Credit. (In the above point the Supplies Expenses Account is Nominal Account, So the "All Income and Expenses Account Debit" Rule will be applied. Account Payable or Creditor Account is Personal Account, So the " Credit the giver rules will apply. )
(For better Understanding of Debit and Credit you need to understand about Golden rules of Accounting.)