When it comes to accounting and bookkeeping, Debit and Credit are the two words you shall come across the most often.
You can have a better knowledge of the accounting process by learning how debit and credit function. It might even make it easier for you to understand complex accounting concepts.
What is a Debit and Credit?
An organization’s finances are impacted by the transactions which take place within itself. Numbers are usually noted down under two different accounts, the debit column and the credit column. The debit column is on the left whereas the credit column is on the right.
To make things simpler, debit is all the money that is flowing into an account (notated as Dr.) and credit is all the money that is flowing out (notated as Cr.).
When you have too many transactions taking place in your day-to-day system, it becomes important to keep record of them. Without that, you would probably be lost with your finances.
Let’s say Rs 25,000 cash is coming into an organization with the sales of 5 items, so we would put that as Rs 25,000 under debit (Dr.) in the cash account and as credit (Cr.) under the Sales account.
Meanwhile, if you had to take a loan of Rs 10,000 to keep your business up and running, that would be recorded as Debit (Dr.) under the Loans payable account and as credit (Cr.) under the cash account.
How does it work?
Accounting items such as debits and credits balance each other out. It’s critical to understand the fundamentals of debit and credit in order to keep correct records for your business.
A debit is considered an accounting entry that will add to asset or expense accounts while subtracting from liability, revenue, and equity accounts.
Whereas a credit is considered as an accounting entry which works in the completely opposite manner by subtracting from asset or expense accounts and adding to liability, equity or revenue accounts.
When documenting a transaction, every debit entry must be accompanied by a credit entry for the equal monetary amount, and vice versa.
Any transaction’s total debits and credits must always equal one another, hence an accounting transaction is always said to be balanced. It would be impossible to compile financial statements if a transaction was not in balance.
As a result, the most important control on accounting reliability is the implementation of debits and credits in a two-column transaction recording format.
While handling transactions, there can always arise some sort of confusion. For example- if you say the Cash account is being debited, it means that there’s an addition to the cash balance.
But if an accounts payable is being debited, it would mean that the liability amount to be paid is increasing. These distinctions arise as a result of the fact that debits and credits have different effects on various types of accounts.
If you are using an accounting software, you can record transactions using a journal entry.
Types of Accounts
Now let’s take a look at the main 5 types of accounts that are affected during transactions.
An asset refers to a resource that is owned by a company which adds value to it. Here, a debit raises the balance and a credit reduces the balance. This account includes cash, inventory, accounts receivables, vehicles, prepaid expenses, property and equipment, etc.
Liabilities are financial requirements that a firm must pay. Here, a debit reduces the balance and a credit raises the balance. This account includes accounts payable, income tax payable, bank fees, loans payable, etc.
Equity is the total value of net assets if we remove all liabilities from them (basically, all assets – liabilities). Here, a debit reduces the balance, while a credit raises it.
This account includes stocks, bonds, real estate, mutual funds, available-for-sale securities, debt security, pension and retirement plans, derivative instruments, etc.
In addition to the above, these 2 accounts are also crucial to the accounting statement-
Revenue means the total amount of income that is generated from the company’s usual operations of selling goods and services. Here, a debit reduces the balance and a credit raises the balance. Examples are service revenue, sales revenue, investment income, interest income, etc.
The cost of operations that a firm incurs in order to earn revenue is known as expense. Here, a debit raises the balance and a credit reduces the balance. Examples for expenses are as such- salaries, advertising, rent, utilities, travel, etc.
To sum it all up, here are some main pointers that shall help you to get a basic understanding of Debit and Credit.
- Debit entry is made on the left hand side of the account-keeping book.
- Debit raises assets and expense accounts.
- Debits rise and credits decline.
- Debits will lower the liability, revenue and equity accounts.
- Credit entry is made on the right hand side of the account-keeping book.
- Credit declines assets and expense accounts.
- Credits decline and debits rise.
- Credits tend to raise the liability, revenue and equity accounts.
To get a finer understanding, given below is an outline on how some common accounting transactions are noted.
- If there is a sale for cash, the cash account will be debited (Dr.) and the revenue account will be credited (Cr.).
- If a company takes out a loan, the cash account will be debited (Dr.) and the loans payable account will be credited (Cr.).
- When it comes to repaying the loan, the loans payable account is debited (Dr.) and the cash account is credited (Cr.).
- If the company is purchasing supplies for cash, the supplies expense account will be debited (Dr.) and the cash account will be credited (Cr.).
If a company purchases Machinery worth Rs 20,000 and pays for it in cash, it’s understandable that the company’s cash is reducing and their machinery is being increased.
Therefore, the Machinery account will be debited (Dr.) by Rs 20,000 and the Cash account will be credited by Rs 20,000 (Cr.).
Make sure to remember that for each entry on the Debit side, there must be one on the Credit side resulting in the balancing of the books. If your book is balanced in the end, your transactions recorded stand correct.
Finding It Complicated? We Can Help
If you are a business owner, understanding accounting concepts can be a difficult task and in my opinion it’s no needed.
That’s why we’ve built an easy-to-understand accounting software – ProfitBooks.
You can easily record your business transactions without worrying about debit & credit. ProfitBooks takes care of the accounting part in the backend.
In addition to this, we also offer remote bookkeeping service – where you just need to send us your invoices, bills, bank statements, etc and we record those transactions correctly in the accounting software.
Got questions, post your queries in the comments section below.