Rules of Debit and Credit, Concept of Debit and Credit Entries
Rules of Debit and Credit: The left hand side of an account is called the debit side; while the right hand side is called the credit side. An entry on the left side of an account is called a debit entry, or merely a debit, an entry on the right side is called a credit entry or credit. The act of recording an entry on the left side of an account is called debiting the account; and recording an entry on the right side of an account is called crediting the account. The difference between the total debits and total credits in an account is the account balance. Double entry system means the recording of both the aspects i.e. debit and credit. check out more details for debit and credit concepts from below…
THE CONCEPTS OF ‘ACCOUNT’, ‘DEBIT’ AND ‘CREDIT’
The concept of Account
- An account is defined as a summarized record of transactions related to a person or a thing e.g. when the business deals with customers and suppliers, each of the customers and supplier will be a separate account.
- The account is also related to things – both tangible and intangible. e.g. land, building, equipment, brand value, trademarks etc are some of the things. When a business transaction happens, one has to identify the “account‘ that will be affected by it and then apply the rules to decide the accounting treatment.
- Typically, an account is expressed as a statement in form of English letter “T‘. It has two sides. The left hand side is called as ―Debit‘ side and the right hand side is called as ―Credit‘ side. The debit is denoted as “Dr‘ and the credit by “Cr‘. The convention is to write the Dr and Cr labels on both sides as shown below. Please see the following example:
Personal Accounts: ‘Debit the receiver and credit the giver’
Real Accounts: ‘Debit what comes in and credit what goes out’
Nominal Accounts: ‘Debit all expenses and losses and credit all incomes and gains’ from extent to include gains’
Personal Accounts: ‘Debit the receiver and credit the giver’, i.e. debit the account of the person who receives something and credit the account of the person who gives something. For example, if you purchase goods from Ram on credit, the two accounts involved are Goods (Purchase) Account and Ram’s Account. The latter account is a personal account. Since, Ram is the giver in this transaction, his account will be credited. Similarly, if cash is paid to Ram, Ram’s Account will be debited since he is the receiver. Thus, the account of a person is debited with any benefit such person receives and is credited with any benefit such person imparts.
- (a) These persons could be natural persons like Suresh‘s A/c, Anil‘s a/c, Rani‘s A/c etc.
- (b) The persons could also be artificial persons like companies, bodies corporate or association of persons or partnerships etc. Accordingly, we could have Videocon Industries A/c, Infosys Technologies A/c, Charitable Trust A/c, Ali and Sons trading A/c, ABC Bank A/c, etc.
- (c) There could be representative personal accounts as well. Although the individual identity of persons related to these is known, the convention is to reflect them as collective accounts. e.g. when salary is payable to employees, we know how much is payable to each of them, but collectively the account is called as “Salary Payable A/c‘. Similar examples are rent payable, Insurance prepaid, commission pre-received etc. The students should be careful to have clarity on this type and the chances of error are more here.
Real Accounts: ‘Debit what comes in, and credit what goes out’, i.e. debit the account of the thing which comes in and credit the account of the thing which goes out. For example, where furniture is purchased for cash, furniture account is debited while cash account is credited.
Nominal Accounts: ‘Debit all expenses and losses and credit all incomes and gains’ i.e. debit the accounts of expenses and losses and credit all incomes and gains. For example, if firm/business pays salary to its clerk, the two accounts involved are salary account and cash account. Salary account is a nominal account. Salary paid is an expense of the business and therefore this account will be debited. Similarly if interest is received, interest account will be credited, since interest is an income item.
The concept of Debit and Credit
- In double entry book-keeping, debits and credits (abbreviated Dr and Cr, respectively) are entries made in account ledgers to record changes in value due to business transactions.
- Debit is derived from the latin word – debitum, which means “what we will receive”. It is the destination, who enjoys the benefit.
- Credit is derived from the latin word – credre which means “what we will have to pay”. It is the source, who sacrifices for the benefit.
- The source account for the transaction is credited (an entry is made on the right side of the account‘s ledger) and the destination account is debited (an entry is made on the left).
- Each transaction‘s debit entries must equal its credit entries.
- The difference between the total debits and total credits in a single account is the account‘s balance. If debits exceed credits, the account has a debit balance; if credits exceed debits, the account has a credit balance.
Significance of Debit and Credit
(a) Debit in Personal Accounts
(i) If the account is new, debit implies that the person whose account is being debited has become debtor of the business.
(ii) If the account is already there and the person whose account is being debited is already a debtor of the business, the new debit implies that the sum due from that person has increased.
(iii) If the account of a person who is a creditor of the business is debited, the debit implies that the amount due to that person has decreased by the amount of debit. It is also conceivable that the creditor may become a debtor after the debit entry; it will happen when the amount of the debit exceeds the amount for which the person was a creditor immediately before the debit.
(b) Credit in Personal Accounts
(i) If the account is new, credit implies that the person whose account is being credited has become creditor of the business.
(ii) If the account of a creditor of the business is credited, it will mean that the amount which is due to that person has increased by the amount of the fresh credit. Credit in the account of a debtor of the business signifies that the amount for which the debtor was liable to the business has diminished by the amount of the credit entry. It is also possible that a debtor may become a creditor after the credit.
(c) Debit in Real Accounts: A debit in real account means that either the value of the asset whose account is being debited has increased or the business has acquired more of that asset.
(d) Credit in Real Accounts: A credit in the real account implies that either the value of the asset whose account is being credited has decreased or the business has disposed of a part or the whole of the asset for the amount of the credit.
(e) Debit in Nominal Accounts: A debit in nominal account signifies that there has been an expense or loss of the amount of the debit or some income or profit has diminished by the amount of the debit.
(f) Credit in Nominal Accounts: A credit in a nominal account implies that there has been an income or a profit of the amount of credit or some expense or loss has diminished by the amount of the credit.
Analyzing Transactions for Recording
If the three fundamental rules described above are kept in mind, it would be possible to record all the transactions correctly. Follow these simple steps to record all the transactions:
- Identify the two accounts involved in the transaction.
- Find out the type of account for both the accounts involved in the transaction.
- Apply the rules of debit and credit.
For example, payment of salary is a transaction. It involves Salary Account and the Cash Account. Salary Account is a nominal account whereas the Cash Account is a real account. Salary is an Expense. Rule of Nominal Accounts says “Debit all expenses and losses”. So, Salary Account will be debited. Whereas rule of real accounts says credit what goes out. Here cash is going out. So, Cash Account will be credited