Introduction to Debits and Credits
Debits and credits are two sides of the same transaction in the world of accounting. They get recognition at the time of recording the financial transactions of an entity. The left-hand side will show the credit amounts, whereas the values on the right-hand side will be debit amounts.
The system categorizes all sorts of accounts in five different kinds. They are Assets, Liabilities, Owner’s Equity, Income, and expenditure. And every transaction will affect two accounts. While one account gets a debit, the other account will simultaneously get the credit. It will keep the entries in balance. It is the Double-entry system of accounting.
For example, suppose a business entity makes a sale of US$500 for cash. There is the involvement of two accounts- Cash (Asset) and Sales (Income). The cash account will be increased or debited for US$500, and the sales account will get the credit with the same amount. Hence the accounts will remain in balance.
Journal and Ledger
The first step in accounting is to pass a Journal Entry for every transaction. Each entry will consist of either of the five above categories and have a debit and credit side. The sum for all debits should be equal to all credits for a journal entry to be in balance or correct. These figures are the backbone of all further accounts for an entity. Hence, proper balancing is essential to check if the entries have been recorded correctly or not.
The Journal entry for the above example of the sale of US$500 will be:
Cash A/c Debit(Normally denoted as Dr.)
To Sales A/c Credit (Normally denoted as Cr.)
All journal entries find their place ultimately to their respective ledger accounts. i.e., consolidation of all amounts/ entries for a particular account happens. An account has a debit balance if the total of the debit side of it is more than the sum of the credit side. Similarly, an account shall have a credit balance if the amount on the credit side is more than the total on the debit side. Continuing with the above example, US$500 will be added on the debit side of the ledger of cash a/c. Similarly, the accounting of sales a/c will get an entry of US$500 on its credit side.
Usage of debits and credits
With assets and expenditure accounts:
All the assets and expenditure accounts usually have a debit balance. Assets like cash, bank accounts, land, plant and machinery, and accounts receivables will always have a debit balance. It means that the debit will increase an asset account, and a credit will decrease an asset account.
Suppose an entity makes a cash sale; cash is the asset involved in this transaction. There is a debit in the cash account and hence, an increase in the cash balance. Now suppose the entity purchases machinery for cash. Two assets in the transaction are- machinery and cash. The machinery account is debited, meaning there is an addition to machinery owned by the entity. Here, the cash balance goes down, so cash a/c gets a credit.
Expenditure accounts like salaries, wages, electricity, etc., will also have a debit balance. It is because a debit in such accounts increases the balance and a credit reduces it. If an entity pays a salary of US$1000 to its employee, the salary account will be debited by US$1000. Hence, its balance will increase.
With liabilities, owner’s equity, and income accounts.
Liabilities, owner’s equity, and income accounts will mostly have a credit balance. Liabilities like accounts payable and sundry creditors will have a credit balance. A credit in a liabilities account will increase its balance, and a debit will reduce it. Suppose an entity receives payment of US$5000 from its sundry creditor, cash or bank a/c will be debited by US$5000, and the same amount will credit the sundry creditor account. Hence, there will be an increase in the outstanding balance of the sundry creditor.
Revenue accounts like sales and services, interest income, etc., also have a credit balance. A debit in revenue accounts will decrease its balance, and a credit will increase it. Suppose an entity earns interest income from its deposits with a bank. The interest account gets credit by that amount. It means that there is an increase in interest a/c balance.
The owner’s equity gets a credit when there is an addition by way of fresh capital infusion or by net profits, and as a result, its credit balance increases. For example, suppose an individual decides to make a fresh capital infusion of US$50000 in his business. Two accounts are involved- cash a/c (asset) and owner’s equity a/c. Cash a/c will be debited by US$50000, and the cash balance will increase by the same amount. The owner’s equity a/c will get credit by US$50000, and its credit balance will also increase.
Correct debits and credits are essential for the books of accounts to be proper and reliable. A wrong debit and credit entry can lead to wrong ledgers, resulting in a mismatch in the trial balance and the balance sheet. Hence, for the preparation of accurate financial statements, due care must be taken to ensure error-free entries.