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concept of debit and credit

The debit and credit are two of the most crucial accounting terms you need to understand. This is particularly important for accountants and bookkeepers using double-entry accounting.

Debit and credit are the true backbones of accounting. Therefore, any transaction recorded in a ledger, whether hand-written or in your accounting software, needs debit and credit entries.

 Moreover, debit and credit are used to monitor incoming and outgoing money in your business account. A debit is a money  coming into business, whereas a credit is money going out from business. However, most businesses use a double-entry system for accounting.

What are debit and credit?

Debit

A debit is an accounting entry that increases an assets or expenses account or decreases a liability or equity account. Its position to the left in an accounting entry. 

Credit

A credit is an accounting entry that increases a liability or equity account or decreases an asset or expense account. Therefore, it is positioned to the right in an accounting entry.

Why are Debit and Credit is important?

The most important concept to understand when dealing with debit and credit is that the total amount of debits must be equal to the total amount of credit in every transaction. Therefore, it is vital to balance each transaction in double-entry accounting to have a clear and accurate general ledger, financial statement and look into the financial health of your business.

Examples of Debit and Credit

Afaq corporation sells goods to a customer for $1,000 in cash. This resulted in revenue of $1,000 and cash of $1,000.Afaq must record an increase of the cash asset account with a debit and an increase of revenue account with credit, the entry  will be

  Debit  Credit 
Cash  1,000  
      revenue   1,000

Afaq Corporation also buys a machine for $15000 on credit. This result in addition to the machinery fix asset account with a debit and increase in the account payable liability account with credit, the entry  will be

  Debit Credit
Machinery  15,000  
      Account payable   15,000

Difference between Debit and Credit

In understanding the difference between debit and credit, you must know about two sides of  accounts (debit and credit) will always be affected in every accounting transaction. The total transactions recorded in debit and credit for each transaction must be the same as the other. So that you have to balance the transaction. If the transaction is not level, it will affect the financial statement.

That’s way, debit and credit in a two-column transaction recording format are essential. Some points explain the difference between the two, namely,

  •  Debit is the left side of the general ledger account, while credit is the right side of the general ledger account. The debit account will record all the recipient accounts while the credit account is for the giver.
  • Debit is used to record increase in asset and expense accounts and decrease in liability, equity and income accounts. However, credit is used to record decreases in asset and expense accounts and increase in liability, equity and income accounts. 
  • In general journal account with a debit balance is recorded first after that accounts with a credit balance are recorded by the following word “TO”.

  •  Some major examples of the increase in debit is due to an increase in cash, inventory, equipment, machinery, building, land, insurance. An increase in shareholder funds, retained earnings, cost, debit, and other causes an increase in credit.

What is the formula of debit and credit?

Asset = liability+ Equity

An increase in the asset is debited, and the decrease in the asset is credited while the increase in liability is credited and the decrease in liability is debited. Whether a debit decrease or increase, an account depends on what kind of account.

Accounts Impacted by credit and debit

Generally, debit happens when things are added to accounts. Credit happens when items are subtracted. Seems pretty simple right?

The crafty part in understanding these two categorizations is that both debit and credit have different impacts across different types of accounts.

For example, what happens if you debit an account showing how much you owe someone instead? Is it same as debiting an account that shows how much you were just paid?

The typical accounts in question are:

  • Assets Account
  • Liability Accounts
  • Expense Accounts
  • Equity Accounts
  • Income Accounts

Rules of debit by Accounts

The debit rule says that all accounts of assets and expenses containing a debit balance will increase when debited and reduce when credited. However, when account balances  of liability, equity and income decrease we use debit to show reduce in their balance. So here when it’s debited, what happens in each account type.

Accounts                                              Debit

 Assets                                                  Increase                      

Expenses                                              Increase           

Liability                                                Decrease         

Equity                                                  Decrease           

Income                                               Decrease             

We can look at John’s barbershop to understand a type of transaction that would be labeled on the debit side of an account. For example, John sells hair shampoo to a customer for $45 and  receive payment  in cash.

Looking at the above chart , we can tell that asset ( cash ) will increase by debiting. you would record this $45 increase of money with a debit in the asset account of John’s books

Here is what debiting that account looks like.


John barbershop                     Debit                                       Credit


 Cash account                         $45


Rules of Credit by Account

Opposite to debit, the credit rule” that all accounts of equity, liability and income that normally contain a credit balance will increase in amount when credit is added to them and reduce when a debit is added to them.  However when balances  of asset and expense accounts reduce we use credit to show reduction in assets and expenses. The chart below can help visualize how credit will affect the account.

Accounts                                            Credit

Assets                                                Decrease       

Expenses                                          Decrease 

Liability                                              Increase   

Equity                                                Increase        

Income                                            Increase

Remember when John’s barbershop sold some hair shampoo for $45 cash?

We know that there is always an equal credit entry to a debit entry, and also know that we must credit an account in order to balance out the transaction.

The sale of the hair shampoo would also be labeled as income for the John Barbershop, meaning to show income of $ 45 we will use a sales account.

Here’s what that looks like, alongside our debit. Debits are always listed first and on the left side of the table, while credits are listed on the right.


John barbershop                                   Debit                                           Credit


                                                                $45

 Cash account 


 Sales account                                                                                        $45


Now our debt is completed with equal credit. As a result, the transaction will be balanced and will be reflected properly on the financial statement.

Bottom Line

Debit and credit are two equal but opposite entries in your books and also two backbones of accounting. .If a debit increases in an account, you will decrease the opposite account with a credit.

A debit is an entry made on the left side of an account. It either increases an asset or expenses account or decreases equity, liability, or revenue accounts. 

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