Business, Legal & Accounting Glossary
Debit and credit are formal bookkeeping and accounting terms.
Debits and Credits are the most fundamental concepts in accounting.
In accounting theory, the financial aspects of an entity, stated in terms of units of currency, is calculated using the “accounting equation,” which is that Assets equal Liabilities plus Capital. Each Asset, Liability and Capital account contains debit and credit transactions that allow for the calculation of values for these accounts.
In an accounting system, transactions are recorded using a debit and a credit journal. In each transaction, one account issues a credit, the receipt of which is then recorded as a debit in another account. In an asset account, a debit entry signifies the receipt of new assets, and thus represents an increase in assets. A credit entry signifies a transfer of assets to another account, and thus decreases assets. In a liability account, a debit entry represents a sum to be applied toward the satisfaction of the liability, and therefore decreases the liability. A credit entry signifies a transfer of funds to another account, and therefore increases the liability.
There are different types of accounts and these accounts are expected to hold either a debit balance or a credit balance. Asset accounts and expense accounts are expected to always have a debit balance. Gain, Income and Liability Accounts are expected to always have a credit balance, signifying that they have extended credit to another account.
The terms Debit and Credit have Latin roots. Debit comes from debere, which means “to owe”. The Latin debitum means “debt”. Credit comes from the Latin word credere, which means “to believe” or “to entrust”. It is more common to use the terms in the plural, Debits and Credits.
Historically the Debit side of an account is the left-hand side of a general ledger account, while the Credit side of an account refers to the right-hand side.
The concepts of ‘positive’ and ‘negative’ are different from those of ‘credit’ and ‘debit’. While it is true that an asset account having a debit balance is in receipt of more credits than it has issued and has positive value to the entity being tracked, and a liability account having a credit balance has extended more credit than has been repaid and has a negative value to the entity being tracked, not all accounts carrying a credit balance are liabilities nor are all accounts carrying a debit balance assets. For example revenue accounts usually extend credit to asset accounts, but these credits do not have to be repaid, so they are not liabilities. As another example, expense accounts, having received credits from other asset accounts to pay expenses, carry a debit balance, but are not considered assets.
Computers have no concept of “left” and “right”, so instead, computer accounting systems use negative numbers to represent credits, and positive numbers to represent debits. This makes sense because a debit entry represents an inflow into an account and a credit entry represents an outlay from an account, but can seem counterintuitive until one recognizes that the receiving account is is the nominal debtor and the distributing account is the nominal creditor. For example, a credit (negative value) is recorded in sales account in order for the receipt of the sale amount to be recorded as a debit (positive number) in an asset account.
If the value of the debits is greater than the value of the credits, then the balance on the account is a debit balance and should not be described as a positive value balance, but should be described as an account with a debit balance.
Debit can be abbreviated as Dr., while credit can be abbreviated as Cr.
Debit entries are made on the left side of the vertical line and credit entries are made on the right side of the vertical line.
Debits and credits are neither positive nor negative values. The balance on an account is either a debit or a credit, not a positive or a negative value.
Dividend, Expense, Asset and Losses (abbreviated as “D-E-A-L”) accounts increase in value when debited and decrease when credited, whereas Gains, Income, Revenues, Liability and Stockholder’s (Owner’s) equity (abbreviated as “G-I-R-L-S”) accounts decrease in value when debited and increase when credited.
This distinction is somewhat counter-intuitive, until the nature of those accounts is more closely scrutinized. For example, revenue is coded as a credit. After recording a day’s sales invoices, the company will have credited a certain amount in revenue, but the customer’s ledger will hold a debit balance being the amount of the unpaid invoices. To fully understand this see Double-entry bookkeeping system where Debits and Credits form the core of that system.
For instance, the journal entry for paying the telephone bill might look like this:
The telephone company would record the exact same transaction (from their side) like this:
Confusion also arises where the term debit is also informally referred to as a “charge” as in a charge card or a debit card and that credit is a limit set or an amount granted by a company to its customers as in a credit limit. They are used in a different context in these two cases.
It is often assumed that a debit decreases a balance, and a credit increases it, because this is how the terms are shown on bank statements and using a debit card decreases the balance in one’s bank account. However, this is because bank statements are traditionally written from the bank’s perspective, where the customer’s account is a liability. By withdrawing money, the customer is decreasing the bank’s liability. Since liability accounts normally have a credit balance, the withdrawal of cash from a banking account is reflected on the bank’s balance sheet as a debit.
All the account heads used in Accounting systems are classified under three types of Accounts i.e Real Account, Personal Account, Nominal Account.
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This glossary post was last updated: 21st April, 2020 | 8 Views.