# Debits and credits

In double entry bookkeeping, debits and credits (abbreviated Dr and Cr, respectively) are entries made in account ledgers to record changes in value due to business transactions. Generally speaking, the source account for the transaction is credited (an entry is made on the right side of the account's ledger) and the destination account is debited (an entry is made on the left). Each transaction's debit entries must equal its credit entries.[1][2]

The difference between the total debits and total credits in a single account is the account's balance. If debits exceed credits, the account has a debit balance; if credits exceed debits, the account has a credit balance.[3] For the company as a whole, the totals of debit balances and credit balances must be equal as shown in the trial balance report, otherwise an error has occurred.

Accountants use the trial balance to prepare financial statements (such as the balance sheet and income statement) which communicate information about the company's financial activities in a generally accepted standardized format.

## Aspects of transactions

Increase Decrease
Asset Debit Credit
Liability Credit Debit
Income/Revenue Credit Debit
Expense Debit Credit
Equity/Capital Credit Debit

To determine whether one must debit or credit a specific account we use the modern accounting equation approach which consists of five accounting elements or rules.[4] An alternative to this approach is to make use of the traditional three rules of accounting for: Real accounts, Personal accounts, and Nominal accounts to determine whether to debit or credit an account.[5]

In summary: an increase (+) to an asset account is a debit. An increase (+) to a liability account is a credit. Conversely, a decrease (-) to an asset account is a credit. A decrease (-) to a liability account is a debit.

Debits and credits form two opposite aspects of every financial transaction in double-entry bookkeeping. Debits are entered on the left side of a ledger, and credits are entered on the right side of a ledger. Whether a debit increases or decreases an account depends on what kind of account it is. In the accounting equation: Assets = Liabilities + Equity (A = L + E), if an asset account increases (by a debit), then one must also either decrease (credit) another asset account, or increase (credit) a liability or equity account.

For example, from a bank customer's perspective, when the customer deposits cash into his bank current account (US: checking account), this financial transaction has two aspects: the customer's cash-in-hand (the customer's asset) decreases and the customer's current account balance (the customer's asset) with the bank increases. The decrease in the cash-in-hand asset is the customer's credit while the increase in the asset balance in the bank current account is the customer's debit.

The bank views that transaction using the same rules, but from its different perspective. In that example, the bank's vault cash (asset) increases which is a debit, and the corresponding increase in the customer's current account balance (bank's liability) is a credit. This is why a customer's bank statement issued by the bank shows the bank's liability to the customer, which increases (bank deposits) as credits, and decreases (bank withdrawals and cheques) as debits.

## Commercial understanding

When dealing with one's own business, one must set up various accounts to record all transactions that may take place. When the owner of a business refers to their bank account, they are referring to the business's account, not to their personal account. In addition, all accounts referred to in bookkeeping belong to the business, not to other businesses, regardless of their title. For instance, if my business expects to receive money from another person or company and the account is labelled "Receivable A", this does not imply that the account in question belongs to "Receivable A". It is merely a recording of a current asset (a receivable) of one's own business. Therefore, when assessing any transaction, the transaction is from the point of view of one's own business or the business in question.

All accounts must first be classified as one of the five types of accounts (accounting elements). To determine how to classify an account into one of the five elements, the definitions of the five account types must be fully understood i.e. the definition of an asset according to IFRS is as follows, "An asset is a resource controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity".[6] To understand this definition we can break it down into its constituent parts with an example:

Example: Classify what type of account the business "Bank account" is.
The bank account of a business is "a resource controlled by the entity" as it belongs to the business. "As a result of past events" such as the opening of the business. "From which future economic benefits are expected to flow to the entity" – a business such as a grocers can expect to make money due to the sale of their goods. This basic analogy can be applied to any asset account.
All of the five accounting elements have their own definitions (discussed in other articles see: asset, liability, equity, income and expense) that must be fully understood in order to classify an account correctly.

A business will most often have more than one asset account. An essential asset account in any business is the business's bank account (see: "Accounts pertaining to the five accounting elements" below for more examples) The same applies to liability accounts i.e. if I have borrowed money from two sources (called creditors or payables), then I must open two accounts to represent this present liability, called 'Creditor/Payable A' and 'Creditor/Payable B'. In this manner I may have multiple, different accounts. However all these accounts are all classified as one of the five types of accounts, therefore my entire business can be described in terms of its assets, expenses, liabilities, income and equity/capital (see extended accounting equation). This is the extent of "my" business in relation to accounts, regardless of the business' practices (the business may be a retail franchise, furniture shop, restaurant, etc.). With respect to my business, each of the five accounting elements will have a monetary value, and this can be used to assess the financial position of my business at any time (my success, failure, or any other attributes that I might need to know).

Traditionally, transactions are recorded in two separate columns of numbers (known as a ledger or "T-account"): debit transactions in the left hand column and credit transactions in the right hand column. Keeping the debits and credits in separate columns allows each column to be recorded and totalled independently. Accounts within the general ledger are known colloquially as "T-accounts" due to the "T" shape that the table resembles. Each column of a ledger account lists transactions affecting that account.

## Terminology

The words debit and credit are both used differently depending on whether they are used in a bookkeeping (accounting) sense, or non-accounting sense.

In a non-accounting sense, "debit" is:

• a sum of money taken from a bank account.

"credit" is

• a sum of money placed into a bank account.
• Money available for a client to spend.

The reason why individuals see debits and credits in the above manner, is that the bank statement presented by the bank to the customer is the banks view of the account and so debits and credits appear reversed. And so credit refers to the banks view of the money, they extend credit as money placed in a customers account appears on the credit side of a bank statement.

When recording numbers in accounting, a debit value is placed on the left side of a ledger for a debited account and a credit value is placed on the right side of a ledger for a credited account. A debit or a credit either increases or decreases the total balance in each account, depending on what kind of accounts they are.

Each transaction (say, of value £100) is recorded by a debit entry of £100 in one account and a credit entry of £100 in another account. When people say, "debits must equal credits" they do not mean that the two columns of any ledger account must be equal. If that were the case, every account would have a zero balance (no difference between the columns) which is often not the case. The rule that total debits equal the total credits applies when all accounts are totalled.

More than two accounts may be affected by the same transaction. A transaction for £100 can be recorded as a £100 debit in one account and as multiple credits that total £100 in other accounts.

Example:

I owe creditors A and B £100 each. Thus my liability account for Creditor A has a credit balance of £100 and the same for Creditor B. I pay them off from my bank chequing account, which from my point of view is an asset. I withdraw £200 from my bank account and split it to pay off the two liabilities. In my records, "Creditor A" is one account, "Creditor B" is another account, and "Bank" is a third account. The following transactions affect all three-ledger accounts:

Dr: Creditor A (100)
Dr: Creditor B (100)
Cr: Bank (200)

When I write two £100 cheques for a total of £200, the balance in my bank account is reduced by £200. In my records, my "Bank" ledger account has an asset debit balance, which is reduced by the credit for £200. Amounts in my records for the two creditors are liabilities, which are reduced by the two debits totalling £200.

Therefore for this transaction, the total amount debited = 200 and the total amount credited = 200. When all three accounts are totalled, the total debits equal the total credits.

At the end of any financial period (say at the end of the quarter or the year), the total debits and the total credits for each account may be different and this difference of the two sides is called the balance. If the sum of the debit side is greater than the sum of the credit side, then the account has a "debit balance". If the sum of the credit side is greater, then the account has a "credit balance". If the two sides do equal each other (this would be a coincidence, not as a result of the laws of accounting), then we say we have a "zero balance".

### Debit cards and Credit cards

Debit cards and Credit cards are creative terms used by the banking industry to market and identify each card.[7] From the cardholder's point of view, these terms are unrelated to the terms used in formal accounting.[citation needed] A debit card is used to make a purchase with one's own money. A credit card is used to make a purchase by borrowing money.[8]

However, from the bank's point of view, when a debit card is used to withdraw cash from a chequing account, the withdrawal causes a decrease in the amount of money the bank owes to the cardholder. A decrease to the bank's liability account is a debit. Hence using a debit card causes a debit to a chequing (liability) account in the bank. Likewise, when a credit card is used by a cardholder to pay a merchant for something, this increases the amount the bank must credit to the merchant's chequing account. This obligation is the bank's liability and an increase to a liability account is a credit. Hence using a credit card causes a credit to a liability account in the bank.

### General ledgers

General ledger is the term for the comprehensive collection of T-accounts (so called because there was a pre-printed vertical line in the middle of each ledger page and a horizontal line at the top of each ledger page, like a large letter T). Before the advent of computerised accounting, manual accounting procedure used a book (known as a ledger) for each T-account. The collection of all these books was called the general ledger.

"Day Books" or journals are used to list every single transaction that took place during the day, and the list is totalled at the end of the day. These daybooks are not part of the double-entry bookkeeping system. The information recorded in these daybooks are then transferred to the general ledgers. Modern computer software now allows for the instant update of each ledger account – for example, when recording a cash receipt in a cash receipts journal a debit is posted to a cash ledger account with a corresponding credit in the ledger account for which the cash was received. Not every single transaction need be entered into a T-account. Usually only the sum of the daybook transactions (a batch total) for the day is entered in the general ledger.

## The five accounting elements

There are five fundamental elements[4] within accounting. These elements are as follows: Assets, Liabilities, Equity, Income and Expenses. Income is also called Revenue. The five accounting elements are all affected in either a positive or negative way. It is important to note that a credit transaction does not always dictate a positive value or increase in a transaction and similarly, a debit does not always indicate a negative value or decrease in a transaction. An asset account is often referred to as a "debit account" due to the account's standard increasing attribute on the debit side. When an asset (e.g. an espresso machine) has been acquired in a business, the transaction will affect the debit side of that asset account illustrated below:

Asset
Debits (dr) Credits (cr)
X

The "X" in the debit column denotes the increasing effect of a transaction on the asset account balance (total debits less total credits), because a debit to an asset account is an increase. The asset account above has been added to by a debit value X, i.e. the balance has increased by £X or \$X. Likewise, in the liability account below, the X in the credit column denotes the increasing effect on the liability account balance (total credits less total debits), because a credit to a liability account is an increase.

All "mini-ledgers" in this section show standard increasing attributes for the five elements of accounting.

Liability
Debits (dr) Credits (cr)
X
Income
Debits (dr) Credits (cr)
X
Expenses
Debits (dr) Credits (cr)
X
Equity
Debits (dr) Credits (cr)
X

Summary table of standard increasing and decreasing attributes for the five accounting elements:

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

## Principle

Each transaction that takes place within the business will consist of at least one debit to a specific account and at least one credit to another specific account. A debit to one account can be balanced by more than one credit to other accounts, and vice versa. For all transactions, the total debits must be equal to the total credits and therefore balance.

The general accounting equation is as follows:

$Assets = Equity + Liabilities$
$A = E + L$

The equation thus becomes A – L – E = 0 (zero). When the total debits equals the total credits for each account, then the equation balances.

The extended accounting equation is as follows:

$Assets + Expenses = Equity/Capital + Liabilities + Income$
$A + Ex = E + L + I$

Both sides of these equations must be equal (balance).

Each transaction is recorded in a ledger or "T" account, e.g. a ledger account named "Bank" that can be changed with either a debit or credit transaction.

In accounting it is acceptable to draw-up a ledger account in the following manner for representation purposes:

Bank
Debits (dr) Credits (cr)

### Accounts pertaining to the five accounting elements

Accounts are created/opened when the need arises for whatever purpose or situation the entity may have. For example if your business is an airline company they will have to purchase airplanes, therefore even if an account is not listed below, a bookkeeper or accountant can create an account for a specific item, such as an asset account for airplanes. In order to understand how to classify an account into one of the five elements, a good understanding of the definitions of these accounts is required. Below are examples of some of the more common accounts that pertain to the five accounting elements:

#### Asset accounts

• Cash, bank, accounts receivable, inventory, land, buildings/plant, machinery, Furniture, equipment, vehicles, trademarks and patents, goodwill, prepaid expenses, debtors (people who owe us money), etc.

#### Liability accounts

• Accounts payable, salaries and wages payable, income taxes, bank overdrafts, trust accounts, accrued expenses, sales taxes, advance payments (unearned revenue), debt and accrued interest on debt, etc.

All of the accounts listed in this subsection are payables

#### Equity accounts

• Capital, drawings, common stock, accumulated funds, etc.

#### Income/Revenue accounts

• Services rendered, sales, interest income, membership fees, rent income, interest from investment, recurring receivables, etc.

#### Expense accounts

• Telephone, water, electricity, repairs, salaries, wages, depreciation, bad debts, stationery, entertainment, honorarium, rent, fuel, etc.

### Example

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

Quick Services has acquired a new computer which is classified as an asset within the business. According to the accrual basis of accounting, even though the computer has been purchased on credit, the computer is already the property of Quick Services and must be recognised as such. Therefore, the equipment account of Quick Services increases and is debited:

Equipment (Asset)
(dr) (cr)
500

As the transaction for the new computer is made on credit, the payable "ABC Computers" has not yet been paid. As a result, a liability is created within the entity's records. Therefore, to balance the accounting equation the corresponding liability account is credited:

Payable ABC Computers (Liability)
(dr) (cr)
500

The above example can be written in journal form:

dr cr
Equipment 500
ABC Computers (Payable) 500

The journal entry "ABC Computers" is indented 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 (income) 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 salaries 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 (dr) Credit (cr)
1. Rent 100
Bank 100
2. Bank 50
Sales 50
3. Equipment 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".[9] The term "T-account" is accounting jargon for a "ledger account" and is often used when discussing bookkeeping.[10] The reason that a ledger account is often referred to as a "T" account is due to the way the account is physically drawn on paper (representing a "T"). The left side (column) of the "T" for Debit (dr) transactions and the right side (column) of the "T" for Credit (cr) transactions.

Debits (dr) Credits (cr)

## Contra account

All accounts have corresponding contra accounts depending on what transaction has taken place i.e. when a vehicle is purchased using cash, the asset account "Vehicles" is debited as the vehicle account increases, and simultaneously the asset account "Bank" is credited due to the payment of the vehicle using cash. Some balance sheet items have corresponding contra accounts, with negative balances, that offset them. Examples are accumulated depreciation against equipment, and allowance for bad debts against long-term notes receivable.

## Real, personal, and nominal accounts

Real accounts are assets. Personal accounts are liabilities and owners' equity and represent people and entities that have invested in the business. Nominal accounts are revenue, expenses, gains, and losses. Accountants close nominal accounts at the end of each accounting period.[11] This method is used in the United Kingdom, where it is simply known as the Traditional approach.[5]

Transactions are recorded by a debit to one account and a credit to another account using these three "golden rules of accounting":

1. Real account: Debit what comes in and credit what goes out
2. Personal account: Debit who receives and Credit who gives.
3. Nominal account: Debit all expenses & losses and Credit all incomes & gains
Debit Credit
Real (assets) Increase Decrease
Personal Increase Decrease
Personal (owner's equity) Decrease Increase
Nominal (revenue) Decrease Increase
Nominal (expenses) Increase Decrease
Nominal (gain) Decrease Increase
Nominal (loss) Increase Decrease

## History

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.[12]

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 credere became the English debit and credit. The abbreviations Dr (for debit) and Cr (for credit) likely derive from the original Latin.[13]

## References

1. ^ "Debit Credit Rules". Accounting Explained. AccountingExplained.com. Retrieved 4 August 2011.
2. ^ "Making sense of Debits and Credits in Accounting". Retrieved 5 May 2013.
3. ^ Larson, Kermit; Jensen, Tilly (2005). Fundamental Accounting Principles. McGraw-Hill Ryerson. ISBN 0-07-091649-7.
4. ^ a b Pieters, A. Dempsey, H. N. (2009). Introduction to financial accounting (7th ed.). Durban: Lexisnexis. ISBN 978-0-409-10580-3.
5. ^ a b Accountancy: Higher Secondary First Year (First ed.). Tamil Nadu Textbooks Corporation. 2004. pp. 28–34. Retrieved 12 July 2011.
6. ^ IFRS for SMEs. 1st Floor, 30 Cannon Street, London EC4M 6XH, United Kingdom: IASB (International Accounting Standards Board). 2009. p. 14. ISBN 978-0-409-04813-1.
7. ^ Difference between Credit Card and Debit Card. Diffbetween.org (2012-02-08). Retrieved on 2012-05-04.
8. ^ "Accounting made easy 4 – Debits and Credits". Retrieved 13 March 2011.
9. ^ Weygandt, Jerry J. (2009). Financial Accounting. John Wiley and Sons. p. 53. ISBN 978-0-470-47715-1.
10. ^ Cusimano, David. "Accounting Abbreviations – Helping You Understand Accounting Jargon". Loughborough. Retrieved 18 August 2011.
11. ^ "Account Types or Kinds of Accounts :: Personal, Real, Nominal". Retrieved 2011-04-08.
12. ^ "Peachtree For Dummies, 2nd Ed.". Retrieved 6 Feb 2011.
13. ^ "Basic Accounting Concepts 2 – Debits and Credits". Retrieved 6 Feb 2011.