Debits and credits

This article uses terms related to the American system of accounting known as GAAP (Generally Accepted Accounting Principles). The article still applies when working with the European accounting system known as IFRS (International Financial Reporting Standards).

Debit and credit are formal bookkeeping and accounting terms. They are the most fundamental concepts in accounting, representing the two sides of each individual transaction recorded in any accounting system. A debit transaction can be used to reduce a credit balance or increase a debit balance. A credit transaction can be used to decrease a debit balance or increase a credit balance. To understand which accounts are debited or credited in order to either increase or decrease their amounts, there are five fundamental accounts in accounting. The following are the five fundamental elements of any financial statement namely: Assets, Liabilities, Equity, Income and Expenses. Debits and credits form the basis of the double-entry bookkeeping system (as opposed to the Single-entry bookkeeping system); for every debit transaction there must be a corresponding credit transaction and vice versa. Every debit and credit value is initially recorded in Journals and from these journals transfered to ledgers and finally from these ledgers financial reports can then be prepared.

Introduction

Debits and credits are a system of notation used in bookkeeping to determine how and where to record any financial transaction. In bookkeeping, instead of using addition '+' and subtraction '-' symbols, a transaction uses the symbols "dr" (Debit) or "cr" (Credit). The words "debits" and "credits" do not necessarily represent decreases or increases in an account, as they have different functions depending on the five different financial statement elements. In double-entry bookkeeping debit is used for increases in asset and expense transactions and credit is used for increases in a liability, income (gain) or equity transaction.

For bank transactions, money received in is treated as a debit transaction and money paid out is treated as a credit transaction. Traditionally, transactions are recorded in two columns of numbers: debits in the left hand column and credits in the right hand column. Keeping the debits and credits in separate columns allows each to be recorded and totalled independently. Where the total of the debit value amounts is lower than the total of the credit value amounts, a balancing debit value is posted to that nominal ledger account. That nominal ledger account is now "balanced". An account can have either a credit value balance or a debit value balance but not both.

A debit can also be used to reduce the balance on a liability, income (gain) and equity account. This has the effect of reducing a credit balance by the value of the debit transaction. The balance in a nominal that is normally expected to hold a debit balance may change from a debit balance to a credit balance.

A credit can also be used to reduce the balance on an asset or expense account. This has the effect of reducing a debit balance by the value of the credit transaction. The balance in a nominal that is normally expected to hold a credit balance may change from a credit balance to a debit balance.

In some cases such as fixed assets, all debit transactions will be recorded in one nominal account and all credit transactions will be recorded in a contra nominal account, with the exception when an asset is disposed of. The purchase of an asset will be recorded in a fixed asset account (debit transaction) and the depreciation of the fixed asset (credit transaction) will be recorded in a contra nominal ledger account, fixed asset depreciation.

Origin of the terms debit and credit

While the actual origin of the terms debit and credit is unknown, the first known recorded use of the terms is Venetian Luca Pacioli's 1494 work, Summa de Arithmetica, Geometria, Proportioni et Proportionalita (translated: Everything About Arithmetic, Geometry and Proportion). Pacioli devoted one section of his book to documenting and describing the double-entry bookkeeping system in use during the Renaissance by Venetian merchants, traders and bankers. This system is still the fundamental system in use by modern bookkeepers.

Pacioli wrote of three important aspects that are required to run a business diligently:

1. The most important being cash or any other substantial power.
2. A good accountant and bookkeeper.
3. Good order - Bringing about the concept of arranging all business transactions into a debit or credit.

In its original Latin, Pacioli's Summa used the Latin words debere (to owe) and credere (to entrust) to describe the two sides of a closed accounting transaction. When his work was translated, the Latin words debere and credre became the English debit and credit. The abbreviations Dr (for debit) and Cr (for credit) likely derive from the original Latin.

Operational Principles

Real Accounts

• In real accounts any increment in assets held by the entity is reflected by debiting the relevant asset account and depletion by crediting the asset account.
• If any asset account is debited then it is on account of increment in the value or acquisition of that liability or owner's equity which decreases the resources held by the entity.

As the total resources held by the entity cannot indigenously increment themselves the depletion has to be matched with a fall in resources within the entity.

Personal Accounts

• In Personal Accounts debiting the personal account of any external entity increases the value of the monies receivable from that external entity thus augmenting the resources of the accounting entity.
• Similarly crediting the personal account of any external entity reduces the value of monies receivable from that entity thus reducing the resources of the accounting entity.

Nominal Accounts

• Nominal Accounts are accounts which arise only after commencement of the accounting period and are closed at the end of the accounting period.
• Nominal accounts represent incomes and expenses which accrue during the accounting period and the net result of the total incomes and expenses accruing during the accounting period is absorbed in the profit and loss account as the profit or loss for the accounting period which is then transferred to reserves or shareholders funds or owners equity in accordance to the ownership.
• In Nominal Accounts the Expense accounts whenever debited are done as the Expense incurred represents the Goods and/or Services acquired for consumption by the entity and hence are temporary increments in the resources of the accounting entity.
• In Nominal Accounts the Income accounts are credited as the Income earned is a result of goods or services provided by the accounting entity which is a depletion of the resources of the accounting entity used for earning that income.

Cross-Application over Different Types of Accounts

• The principles apply uniformly to all combinations of accounting entries involving different types of accounts based on varying circumstances.

	Real Account Debited	Personal Account Debited	Nominal Account Debited
Real Account Credited	Acquisition of an Asset in Cash - Machinery Account Debited, Cash Account Credited	Sale of an Asset on Credit - Buyer's Account Debited, Machinery Account Credited	Amortisation or Depreciation of an Asset - Depreciation Account Debited, Machinery Account Credited
Personal Account Credited	Acquisition of an Asset on Credit - Machinery Account Debited, Seller's Account Credited	Transfer of a Debt Receivable to another - New Debtor's Account Debited, Old Debtor's Account Credited	Accrual of Expenditure - Electricity Account Debited, Electricity Company's Account Credited
Nominal Account Credited	Capitalisation of Expenditure - Machinery Account Debited, Research and Development Account Credited	Sale of Goods on Credit - Buyer's Account Debited, Sales Account Credited	Inter head transfer of Expenditure - New Expenditure Head Debited, Old Expenditure Head Credited

Simple Thumb Rules to remember which accounts to credit and which to debit:

Personal accounts: Debit: the receiver; Credit: the giver

Real/Asset Accounts: Debit: what comes in; Credit: what goes out

Nominal/Expense Accounts: Debit: all expenses/losses; Credit: all income/gains

The five accounting elements and how they are affected

The five accounting elements are all affected in either a positive or negative way. Note: A credit transaction does not always dictate a positive value or increase in a transaction. An asset for example is usually a debit transaction, where, when an asset has been acquired in a business the transaction will affect the debit side of an asset account i.e. an asset will increase on the debit side. For example:

Asset
Debits (dr)	Credits (cr)
X

Where "X" denotes the effect of a transaction on the asset account. Therefore with all of the indicated accounts (Assets, Liability, Equity, Income and Expenses), the accounts will all increase on the debit or credit side denoted by the "X". Therefore the reverse will be true for all the accounts if they are decreased i.e. to decrease an asset account, the asset account must be credited.

Standard increasing attributes for the other four accounts are as follows:

Liability
Debits (dr)	Credits (cr)
	X

Income
Debits (dr)	Credits (cr)
	X

Expenses
Debits (dr)	Credits (cr)
X

Equity
Debits (dr)	Credits (cr)
	X

Debit and Credit principle

Each transaction consists of debits and credits, and for every transaction they must be equal.

For Every Transaction: The Value of Debits = The Value of Credits

The extended accounting equation must also balance: 'A + E = L + OE + R'

(where A = Assets, E = Expenses, L = Liabilities, OE = Owner's Equity and R = Revenue)

So 'Debit Accounts (A + E) = Credit Accounts (L + R + OE)'

Debits are on the left and increase a debit account and decrease a credit account.

Credits are on the right and increase a credit account and decrease a debit account.

In all accounting operations there is always an effect on the accounting formula:

A = E + L

When a transaction takes place, traditionally the transaction would be recorded in a ledger or "T" account. A "T" account represents any account that is opened e.g. "Bank" that can be effected with either a debit or credit transaction. In accounting a debit (dr) is recognized on the left side of the T-account and the Credit (cr) is recognized on the right-hand side. In accounting it is acceptable to draw-up a ledger account in the following manner for representation purposes:

Bank
Debits (dr)	Credits (cr)

Examples of accounts pertaining to the five accounting elements:

• Asset accounts: Bank, Receivables, Inventory etc...
• Liability accounts: Payables, Loans, Bank overdrafts etc...
• Equity accounts: Capital, Drawings etc...
• Income accounts: Services rendered, interest income etc...
• Expense accounts: Telephone, Electricity, Repairs, Salaries etc...

There are numerous accounts related to the five accounting elements which should be reviewed before understanding the following example:

Worked example: Quick Services business purchases a computer for ₤500 for the receptionist, on credit, from ABC Computers. Recognize the following transaction for Quick Services in a ledger account (T-account):

Equipment (Asset)
(dr)	(cr)
500

To balance the accounting equation the corresponding account is created:

Payables (Liability)
(dr)	(cr)
	500

The above example can be written in journal form:

Equipment 500

ABC Computers (Payable) 500

Note the indentation of "ABC Computers" to indicate that this is the credit transaction. It is accepted accounting practice to indent credit transactions recorded within a journal.

In the accounting equation form:

A = E + L
500 = 0 + 500 (The accounting equation is therefore balanced)

Further Examples

1. A business pays rent with cash: you increase rent (expense) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.
2. A business receives cash for a sale: you increase cash (asset) by recording a debit transaction, and increase sales (revenue) by recording a credit transaction.
3. A business buys equipment with cash: You increase equipment (asset) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.
4. A business borrows with a cash loan: You increase cash (asset) by recording a debit transaction, and increase loan (liability) by recording a credit transaction.
5. A business pays salarys with cash: you increase salary (expenses) by recording a debit transaction, and decrease cash (asset) by recording a credit transaction.
6. The totals show the net effect on the accounting equation and the double-entry principle where, the transactions are balanced.

	Account	Debit	Credit
1.	Rent	100
	Bank		100
2.	Bank	50
	Sale		50
3.	Equip.	5200
	Bank		5200
4.	Bank	11000
	Loan		11000
5.	Salary	5000
	Bank		5000
6.	Total (Dr)	21350
	Total (Cr)		21350

'T' Accounts

The process of using debits and credits creates a ledger format that resembles the letter 'T'. The term 'T' account is commonly used when discussing bookkeeping. Debits are placed on the left and credits on the right.

Debits	Credits

TYPE	DEBIT	CREDIT
Asset	+	−
Liability	−	+
Income	−	+
Expense	+	−
Equity	−	+

Therefore, if an Asset account is debited, the Asset amount (value) is increased. Same with an Expense account. If a Liability or an Income account is debited, the numerical figure will decrease, etc. If a particular account is credited, there must be a corresponding Debit in another account in order to balance the transaction.

Debit cards and credit cards are creative terms used by the banking industry to market and identify each card. These account names do not refer to the accounting terms: debts and credits.

External links

• Debits and Credits
• YouTube Presentation - A valuable explanation in an audio/visual format