Debits and Credits
The financial statements of an organization are affected financially by business transactions. In two accounts with the debit column on the left and the credit column on the right, we record the numbers related to these transactions.
- Debits: An accounting debit is an addition to an asset or cost account or a subtraction from a liability or equity account. In an accounting entry, it is placed to the left.
- Credits: An accounting entry known as a credit increases or decreases an asset or expense account, depending on the kind of account. A financial entry places it to the right.
Every time an accounting transaction is created, at least two accounts are always touched, with one account receiving a debit entry and the other receiving a credit entry. The maximum number of accounts that can be used in a transaction is unlimited, although there is a minimum requirement of two accounts.
An accounting transaction is always referred to as being "in balance" when the totals of the debits and credits for it match one another. The ability to produce financial statements would be lost if a transaction did not balance. As a result, the most crucial of all controls over accounting correctness is the use of debits and credits in a two-column transaction recording format.
Regarding the fundamental significance of a debit or credit, there can be a great deal of uncertainty. For instance, debiting a cash account results in an increase in the amount of cash on hand. Debiting an accounts payable account, on the other hand, implies a reduction in the liability for those payments.
These variations result from the fact that debits and credits affect several broad types of accounts in various ways, including:
- Asset accounts - A debit raises the balance, whereas a credit lowers it.
- Liability accounts - A debit reduces the balance, whereas a credit raises it.
- Equity accounts - A debit reduces the balance, whereas a credit raises it.
Assets = Liabilities + Equity
The guidelines for using debits and credits are listed below.
- Changes to Debit Balances: When a debit (left column) is added to an account that typically has a debit balance, the amount in that account will rise, and when a credit (right column) is added to the same account, the amount will fall. The categories of accounts covered by this rule include dividends, assets, and expenses.
- Changes to Credit Balances: When a credit (right column) is added to an account, the balance in that account will go up, and when a debit (left column) is put to the same account, the balance will go down. This rule is applicable to liabilities, revenues, and equity types of accounts.
- Totals Must Match: In a transaction, the sum of the debits and the credits must be equal. An accounting transaction is deemed to be out of balance if this occurs, and the accounting software will not accept it.
The use of debits and credits are noted in the bullet points below for the more typical commercial transactions:
- Sale for cash: Debit the revenue account, then credit the cash account.
- Sale on credit: Debit the revenue account, then credit the cash account.
- Receive cash in payment of an account receivable: Debit the bank account for cash, Charge the account for unpaid debt
- Purchase supplies from supplier for cash:Credit the cash account while debiting the supply expense account.
- Purchase supplies from supplier on credit: Credit the accounts payable account while debiting the supply expenditure account.
- Purchase inventory from supplier for cash: Credit the cash account while debiting the inventory account.
- Purchase inventory from supplier on credit: Debit the accounts payable account and credit the inventory account.
- Pay employees: Debit the accounts payable account and credit the inventory account.
- Take out a loan: Debiting your checking account and crediting your accounts payable for loans.
- Repay a loan: Credit the cash account while debiting the payable loans account.