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Debits and credits

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Debits and credits
Accountancy
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Accountant Accounting period Accrual Bookkeeping Cash and accrual basis Cash flow forecasting Chart of accounts Convergence Journal Special journals Constant item purchasing power accounting Cost of goods sold Credit terms Debits and credits Double-entry system Mark-to-market accounting FIFO and LIFO GAAP / IFRS Management Accounting Principles General ledger Goodwill Historical cost Matching principle Revenue recognition Trial balance Fields of accounting

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[1] To determine whether one must debit or credit a specific account we use the modern accounting equation approach which consists of five accounting elements or rules. Debits are entered on the left side of a ledger. if an asset account increases (by a debit). a decrease (-) to an asset account is a credit. or increase (credit) a liability or equity account.[] Aspects of transactions Increase Asset Liability Income/Revenue Expense Equity/Capital Decrease Debit Credit Credit Credit Debit Debit Debit Credit Credit Debit In summary: an increase (+) to an asset account is a debit.[] An alternative to this approach is to make use of the traditional three rules of accounting for: Real accounts. Whether a debit increases or decreases an account depends on what kind of account it is. and Nominal accounts to determine whether to debit or credit an account. An increase (+) to a liability account is a credit. and credits are entered on the right side of a ledger. Conversely. Debits and credits form two opposite aspects of every financial transaction in double-entry bookkeeping.Debits and credits € € € 2 GAAS / ISA Internal audit Sarbanes€Oxley Act Accounting qualifications € € € € € € € € € € € € € € € CIA CA AIA CPA CCA CGA CMA CAT AAT CTP CFE CICA ACCA CIMA CGMA Debit and credit are the two fundamental aspects of every financial transaction in the double-entry bookkeeping system in which every debit transaction must have a corresponding credit transaction(s) and vice versa. In the accounting equation: Assets = Liabilities + Equity (A = L + E). then one must also either decrease (credit) another asset account. . Debits and credits are a system of notation used in bookkeeping to determine how to record any financial transaction. In financial accounting or bookkeeping. "Dr" (Debit) means left side of a ledger account and "Cr" (Credit) is the right side of a ledger account. A decrease (-) to a liability account is a debit. Personal accounts.

furniture shop. This is why a customer's bank statement issued by the bank shows the bank's liability to the customer. Keeping the debits and credits in separate columns allows each column to be recorded and totalled independently.e. when the customer deposits cash into his bank current account (US: checking account). In addition. when assessing any transaction. To determine how to classify an account into one of the five elements. Accounts within the . regardless of the business' practices (the business may be a retail franchise. or any other attributes that I might need to know). The bank account of a business is "a resource controlled by the entity" as it belongs to the business. With respect to my business. All accounts must first be classified as one of the five types of accounts (accounting elements). failure. All of the five accounting elements have their own definitions (discussed in other articles see: asset. the bank's vault cash (asset) increases which is a debit. The decrease in the cash-in-hand asset is the customer's credit while the increase in the asset balance in the bank current account is the customer's debit. expenses. the definition of an asset according to IFRS is as follows. and decreases (bank withdrawals and cheques) as debits. In this manner I may have multiple. It is merely a recording of a current asset (a receivable) of one's own business. different accounts. but from its different perspective. this financial transaction has two aspects: the customer's cash-in-hand (the customer's asset) decreases and the customer's current account balance (the customer's asset) with the bank increases. if I have borrowed money from two sources (called creditors or payables). For instance. regardless of their title. and the corresponding increase in the customer's current account balance (bank's liability) is a credit. and this can be used to assess the financial position of my business at any time (my success. the transaction is from the point of view of one's own business or the business in question. etc. However all these accounts are all classified as one of the five types of accounts. then I must open two accounts to represent this present liability. In that example. one must set up various accounts to record all transactions that may take place. each of the five accounting elements will have a monetary value.Debits and credits For example. income and equity/capital (see extended accounting equation). "As a result of past events" such as the opening of the business. An essential asset account in any business is the business's bank account (see: "Accounts pertaining to the five accounting elements" below for more examples) The same applies to liability accounts i. transactions are recorded in two separate columns of numbers (known as a ledger or "T-account"): debit transactions in the left hand column and credit transactions in the right hand column. equity. which increases (bank deposits) as credits. not to their personal account. The bank views that transaction using the same rules. not to other businesses.[] To understand this definition we can break it down into its constituent parts with an example: Example: Classify what type of account the business "Bank account" is. "An asset is a resource controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity". restaurant. income and expense) that must be fully understood in order to classify an account correctly. A business will most often have more than one asset account. therefore my entire business can be described in terms of its assets. all accounts referred to in bookkeeping belong to the business. "From which future economic benefits are expected to flow to the entity" € a business such as a grocers can expect to make money due to the sale of their goods. called 'Creditor/Payable A' and 'Creditor/Payable B'. liability. this does not imply that the account in question belongs to "Receivable A".). from a bank customer's perspective. 3 Commercial understanding When dealing with one's own business. When the owner of a business refers to their bank account. Therefore. This basic analogy can be applied to any asset account. they are referring to the business's account. the definitions of the five account types must be fully understood i. if my business expects to receive money from another person or company and the account is labelled "Receivable A".e. This is the extent of "my" business in relation to accounts. Traditionally. liabilities.

"credit" is money that a creditor makes available to a client to borrow. according to wordnet. Thus. "debits must equal credits" they do not mean that the two columns of any ledger account must be equal. Each transaction (say. the total debits and the total credits for each account may be different and this difference of the two sides is called the balance. "credit" in this sense is not an accounting term. If the sum of the credit side is greater. Therefore for this transaction. The following transactions affect all three-ledger accounts: Dr: Creditor A (100) Dr: Creditor B (100) Cr: Bank (200) When I write two •100 cheques for a total of •200. the balance in my bank account is reduced by •200. However. This may seem confusing at first. I withdraw •200 from my bank account and split it to pay off the two liabilities. If the sum of the debit side is greater than the sum of the credit side. . which is reduced by the credit for •200. every account would have a zero balance (no difference between the columns) which is often not the case. In the academic field of accounting (bookkeeping). of value •100) is recorded by a debit entry of •100 in one account and a credit entry of •100 in another account. Amounts in my records for the two creditors are liabilities. In my records. In my records. or non-accounting sense.[]Wikipedia:Identifying reliable sources a "debit" is: € A written note on bank account or another financial record of a sum of money owed or spent. If that were the case. Each column of a ledger account lists transactions affecting that account. then the account has a "debit balance". At the end of any financial period (say at the end of the quarter or the year). In a non-accounting sense. and "Bank" is a third account. Thus my liability account for Creditor A has a credit balance of •100 and the same for Creditor B. but one will find when studying accounting that "debit" and "credit" are essential for the double-entry system of bookkeeping. I pay them off from my bank chequing account. In a non-accounting sense. which are reduced by the two debits totalling •200. Example: I owe creditors A and B •100 each. 4 Terminology The words debit and credit are both used differently depending on whether they are used in an accounting sense. according to knol. When people say. although this word comes up regularly in business and therefore accounting. A transaction for •100 can be recorded as a •100 debit in one account and as multiple credits that total •100 in other accounts. More than two accounts may be affected by the same transaction. depending on what kind of accounts they are. A debit or a credit either increases or decreases the total balance in each account.Debits and credits general ledger are known colloquially as "T-accounts" due to the "T" shape that the table resembles. When all three accounts are totalled.[2] "credit" is € Money available for a client to borrow. such dictionary definitions are misleading and the words "debit" and "credit" as used in accounting have little connection with the nonprofessional's understanding of "debit" and "credit". my "Bank" ledger account has an asset debit balance. which from my point of view is an asset. a debit value is placed on the left side of a ledger for a debited account and a credit value is placed on the right side of a ledger for a credited account. or € a sum of money taken from a bank account. the total amount debited = 200 and the total amount credited = 200. The rule that total debits equal the total credits applies when all accounts are totalled. When recording numbers in accounting. "Creditor A" is one account. the total debits equal the total credits. in a non-accounting sense. "Creditor B" is another account.

Not every single transaction need be entered into a T-account. and the list is totalled at the end of the day. These elements are as follows: Assets.g. If the two sides do equal each other (this would be a coincidence. Modern computer software now allows for the instant update of each ledger account € for example.[4] However.Debits and credits then the account has a "credit balance". These daybooks are not part of the Double-entry bookkeeping system. The five accounting elements are all affected in either a positive or negative way. Usually only the sum of the daybook transactions (a batch total) for the day is entered in the general ledger. It is important to note that a credit transaction does not always dictate a positive value or increase in a transaction and similarly. This obligation is the bank's liability and an increase to a liability account is a credit. The information recorded in these daybooks are then transferred to the general ledgers. the withdrawal causes a decrease in the amount of money the bank owes to the cardholder. a debit does not always indicate a negative value or decrease in a transaction. 5 Debit cards and Credit cards Debit cards and Credit cards are creative terms used by the banking industry to market and identify each card. not as a result of the laws of accounting). these terms are unrelated to the terms used in formal accounting. Hence using a debit card causes a debit to a chequing (liability) account in the bank. An asset account is often referred to as a "debit account" due to the account's standard increasing attribute on the debit side. Income is also called Revenue. manual accounting procedure used a book (known as a ledger) for each T-account. from the bank's point of view. A credit card is used to make a purchase by borrowing money. Likewise. Before the advent of computerised accounting. General ledgers Definition: General ledger is the term for the comprehensive collection of T-accounts (so called because there was a pre-printed vertical line in the middle of each ledger page and a horizontal line at the top of each ledger page. like a large letter T). then we say we have a "zero balance". when a debit card is used to withdraw cash from a checking account. Income and Expenses. Liabilities. The five accounting elements There are five fundamental elements[] within accounting.[citation needed] A debit card is used to make a purchase with one's own money. when recording a cash receipt in a cash receipts journal a debit is posted to a cash ledger account with a corresponding credit in the ledger account for which the cash was received. when a credit card is used by a cardholder to pay a merchant for something. When an asset (e. Equity. "Day Books" or journals are used to list every single transaction that took place during the day. A decrease to the bank's liability account is a debit. The collection of all these books was called the general ledger. the transaction will affect the debit side of that asset account illustrated below: .[3] From the cardholder's point of view. an espresso machine) has been acquired in a business. Hence using a credit card causes a credit to a liability account in the bank. this increases the amount the bank must credit to the merchant's chequing account.

the balance has increased by •X or $X.Debits and credits 6 Asset Debits (dr) Credits (cr) X The "X" in the debit column denotes the increasing effect of a transaction on the asset account balance (total debits less total credits). The asset account above has been added to by a debit value X. in the liability account below. Liability Debits (dr) Credits (cr) X Income Debits (dr) Credits (cr) X Expenses Debits (dr) Credits (cr) X Equity Debits (dr) Credits (cr) X Summary table of standard increasing and decreasing attributes for the five accounting elements: ACCOUNT TYPE DEBIT CREDIT Asset Liability Income Expense Equity + • • + • • + + • + . All "mini-ledgers" in this section show standard increasing attributes for the five elements of accounting. because a credit to a liability account is an increase. because a debit to an asset account is an increase. Likewise.e. i. the X in the credit column denotes the increasing effect on the liability account balance (total credits less total debits).

income taxes. e. When the total debits equals the total credits for each account. Furniture. Each transaction is recorded in a ledger or "T" account. vehicles. The general accounting equation is as follows: The equation thus becomes A € L € E = 0 (zero). the total debits must be equal to the total credits and therefore balance. For example if your business is an airline company they will have to purchase airplanes. salaries and wages payable. trademarks and patents. then the equation balances. accounts receivable. land.Debits and credits 7 Principle Each transaction that takes place within the business will consist of at least one debit to a specific account and at least one credit to another specific account. advance payments (unearned revenue). etc. a good understanding of the definitions of these accounts is required. The extended accounting equation is as follows: Both sides of these equations must be equal (balance).g. machinery. buildings/plant. therefore even if an account is not listed below. bank overdrafts. Liability accounts € Accounts payable. equipment. a bookkeeper or accountant can create an account for a specific item. and vice versa. a ledger account named "Bank" that can be changed with either a debit or credit transaction. etc. trust accounts. sales taxes. debt and accrued interest on debt. In order to understand how to classify an account into one of the five elements. debtors (people who owe us money). prepaid expenses. Below are examples of some of the more common accounts that pertain to the five accounting elements: Asset accounts € Cash. All of the accounts listed in this subsection are payables . For all transactions. inventory. bank. such as an asset account for airplanes. goodwill. A debit to one account can be balanced by more than one credit to other accounts. In accounting it is acceptable to draw-up a ledger account in the following manner for representation purposes: Bank Debits (dr) Credits (cr) Accounts pertaining to the five accounting elements Accounts are created/opened when the need arises for whatever purpose or situation the entity may have. accrued expenses.

sales. entertainment. In the accounting equation form: A=E+L 500 = 0 + 500 (The accounting equation is therefore balanced) . a liability is created within the entity's records. accumulated funds. Therefore. even though the computer has been purchased on credit. the payable "ABC Computers" has not yet been paid. Expense accounts € Telephone. membership fees. bad debts. Income/Revenue accounts € Services rendered. rent income. drawings. the computer is already the property of Quick Services and must be recognised as such. etc. 8 Example Quick Services business purchases a computer for $500. common stock. from ABC Computers. salaries. etc. the equipment account of Quick Services increases and is debited: Equipment (Asset) (dr) 500 (cr) As the transaction for the new computer is made on credit. repairs. honorarium. water. It is accepted accounting practice to indent credit transactions recorded within a journal. on credit. Therefore. fuel. rent.Debits and credits Equity accounts € Capital. depreciation. Recognize the following transaction for Quick Services in a ledger account (T-account): Quick Services has acquired a new computer which is classified as an asset within the business. As a result. interest from investment. wages. stationery. etc. electricity. to balance the accounting equation the corresponding liability account is credited: Payable ABC Computers (Liability) (dr) 500 (cr) The above example can be written in journal form: dr Equipment ABC Computers (Payable) 500 500 cr The journal entry "ABC Computers" is indented to indicate that this is the credit transaction. recurring receivables. interest income. According to the accrual basis of accounting.

with negative balances.[] The term "T-account" is accounting jargon for a "ledger account" and is often used when discussing bookkeeping. Total (dr) Total (cr) 21350 21350 5000 5000 11000 11000 5200 50 50 Debit (dr) Credit (cr) 100 100 "T" accounts The process of using debits and credits creates a ledger format that resembles the letter "T". A business receives cash for a sale: you increase cash (asset) by recording a debit transaction. Some balance sheet items have corresponding contra accounts. Bank Sales 3. Rent Bank 2. the transactions are balanced. Equipment 5200 Bank 4. Examples are accumulated depreciation against equipment. 5.[5] The reason that a ledger account is often referred to as a "T" account is due to the way the account is physically drawn on paper (representing a "T"). 3. and simultaneously the asset account "Bank" is credited due to the payment of the vehicle using cash.Debits and credits 9 Further examples 1. and increase loan (liability) by recording a credit transaction. Account 1. the asset account "Vehicles" is debited as the vehicle account increases. and allowance for bad debts against long-term notes receivable. and increase sales (income) by recording a credit transaction. . 2. 4. when a vehicle is purchased using cash. 6. Debits (dr) Credits (cr) Contra account All accounts have corresponding contra accounts depending on what transaction has taken place i. Bank Loan 5. A business pays rent with cash: you increase rent (expense) by recording a debit transaction. and decrease cash (asset) by recording a credit transaction. The left side (column) of the "T" for Debit (dr) transactions and the right side (column) of the "T" for Credit (cr) transactions.e. A business pays salaries with cash: you increase salary (expenses) by recording a debit transaction. and decrease cash (asset) by recording a credit transaction. Salary Bank 6. and decrease cash (asset) by recording a credit transaction. The totals show the net effect on the accounting equation and the double-entry principle where. A business borrows with a cash loan: You increase cash (asset) by recording a debit transaction. that offset them. A business buys equipment with cash: You increase equipment (asset) by recording a debit transaction.

Pacioli's Summa used the Latin words debere (to owe) and credere (to entrust) to describe the two sides of a closed accounting transaction. Real account: Debit what comes in and credit what goes out 2. Personal accounts are liabilities and owners' equity and represent people and entities that have invested in the business. the Latin words debere and credere became the English debit and credit. personal. Personal account: Debit who receives and Credit who gives. [3] Difference between Credit Card and Debit Card (http:/ / diffbetween. where it is simply known as the Traditional approach.com/normal-balances.Debits and credits 10 Real. org/ difference-between-credit-card-and-debit-card/ ). When his work was translated. traders and bankers.[] Transactions are recorded by a debit to one account and a credit to another account using these three "golden rules of accounting": 1. edu/ perl/ webwn?s=credit). 3.[] References [2] Wordnetweb. The abbreviations Dr (for debit) and Cr (for credit) likely derive from the original Latin.princeton. the first known recorded use of the terms is Venetian Luca Pacioli's 1494 work.the-accounting-adventurista.[6] This method is used in the United Kingdom.com/online-accounting-course/07Xpg01. Nominal accounts are revenue. Diffbetween.[7] In its original Latin.accountingcoach.princeton. Accountants close nominal accounts at the end of each accounting period.edu. Geometry and Proportion). expenses. Proportioni et Proportionalita (translated: Everything About Arithmetic. Summa de Arithmetica. and losses. gains.html) € Normal Balances (http://www. Retrieved on 2012-05-04. Nominal account: Debit all expenses & losses and Credit all incomes & gains Debit Real (assets) Personal Increase Increase Credit Decrease Decrease Personal (owner's equity) Decrease Increase Nominal (revenue) Nominal (expenses) Nominal (gain) Nominal (loss) Decrease Increase Increase Decrease Decrease Increase Increase Decrease History While the actual origin of the terms debit and credit is unknown. External links € Debits and Credits (http://www. Retrieved on 2012-05-04.org (2012-02-08). Geometria. This system is still the fundamental system in use by modern bookkeepers. Wordnetweb.html) . princeton. Pacioli devoted one section of his book to documenting and describing the double-entry bookkeeping system in use during the Renaissance by Venetian merchants.edu (http:/ / wordnetweb. and nominal accounts Real accounts are assets.

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