debit and credit in accounting

debit and credit in accounting

The Importance of Debit and Credit in Accounting

1. Introduction to Debit and Credit

Debit and credit sound like preschool concepts, but in fact, they are the much-craved mechanical processes of bookkeeping and accounting; get them right, and both the basic accounting equation (Assets = Liabilities + Owner’s Equity) and the complex puzzle of accounting are solved. An understanding of the rules of debit and credit are essential; the accountant must understand above all other rules that his normal balance his accounts lie in the rules of debit and credit. If a company understands how debit and credit must balance, they will be creating accurate relevant financials that can make or break their business.

Consider that your rent is due. The entry in your accounts would be to: debit rent expense, credit cash. The effect on your company would be a credit to cash (the asset account that shows how much cash your company has) for the amount you paid your landlord, and a credit to owner’s equity for your profit and a debit to rent expense (the equity account that shows the cumulative amount your company has earned less the amount it has spent). A trial balance shows your debits in one column and your credits in another column. If the company is doing, the numbers are supposed to match. If the numbers don’t match, you know you have tinkering to do.

In accounting, debit and credit are the names given to the left and right sides of every T-account. Depending on the type of account, every debit must be balanced by either another debit in another account, or a credit in the same account; and every credit must be balanced by either another credit in another account, or a debit in the same account. This implies that the totals in the two columns should be the same. When you take an accounting course, you compile a set of practice problems and quizzes that drill on the rules of debit and credit so much that you learn which accounts are debt accounts and which accounts are credit accounts. It becomes second nature. You also have to understand the effect on your company.

2. Understanding Debits and Credits

For example, if a business borrowed $50,000 and deposited it into its bank account, there would be the following effects on the accounting equation: The accounting equation would reflect the assets of the business. Because cash is an asset, the accounting equation increases. To maintain the accounting equation, there would have to be a corresponding decrease in another asset account. In this example, the liabilities of the business are increased by the cash deposited in the bank account. It follows that if there is an increase in the liabilities, the other part of the accounting equation, i.e., the owner’s equity, must also increase. In the context of this example, owner’s equity increases due to the increase in assets. Because owner’s equity represents the ownership interest in the business, the amount of liability also increased. The terms “debit” and “credit” make their impact as these terms are used to record financial information that results from a business event such as the deposit of $50,000 into the bank account. By convention, the term “debit” is used to mean an increase in a business asset. Expressed in accounting terminology, the deposit of $50,000 would be recorded as a credit of $50,000 in the bank account, causing the accounting equation to come into balance. Conversely, the term “credit” would mean an increase in a business liability.

The terms “debit” and “credit” are crucial in understanding accounting concepts. The terms are related and occur in every financial transaction. But what is debit and credit? For purposes of a definition, consider the following extract from the book entitled “Debits and Credits,” written by Lee J. Lerner: Debit and credit are terms that actually originate from Latin. The English word “credit” is derived from the Latin word “credere,” meaning “to believe” or “to trust.” The English word “debit” is derived from the Latin word “debere,” once used to describe the action of a debtor in “facing” his creditor. In English, however, the term debit means “owing.”

3. Debit and Credit in Financial Statements

Economic events concerning real-life scenarios imply the actual flow of economic resources, initially located in assets. To accurately represent these economic realizations in financial statements, the standard requires the partition of each real economic event into increases or decreases in assets as a central constant demand. In turn, to maintain the balance of the balance sheet, that is, the symmetrical function of the net income component, the economic events, naturally affected by such components, are allocated to the corresponding symmetry in the equity accounts. The standard also recognizes that symmetry exists between debit and credit and therefore does not intend to use the term register separately. In fact, it is the registration of these daily economic values through bookkeeping that ensures the properties of symmetry we have presented so far.

To present information in an understandable and concise manner, financial statements and the incorporating methodologies must fulfill standardized assumptions proven through extensive usage. To assure the fulfillment of these properties, the financial statements incorporate known symmetries. In this manner, both the income statement and the balance sheet maintain the symmetry of the debit and credit correspondences, regularly used to achieve the preservation of essential accounting symmetries. Thus, the debit and credit terms act as a core of accounting decomposition, since their corresponding financial statements present essential properties of the entire accounting.

4. Balancing Debits and Credits

Every accounting transaction must have a debit and credit of equal value. This dual entry system is recorded based on documentation of all related business transactions. A transaction record is the source of the source documents that are responsible for creating journal entries and serves to provide evidence of those entries in all accounting transactions. To illustrate how this dual entry bookkeeping process works, let’s revisit Store A’s purchase of a truck and its required expenses. Let’s assume the company paid a $1,200 fee for the registration of the truck but have not yet paid for it. The service was made on account, meaning that the salvage yard can be paid by December 15. The original plan was to have paid the fees on December 1. Business records, including the purchase, license fees of $300, and an additional $50 to have the company name painted on the side of the truck, have been charged to the records.

Journaling is a bookkeeping method used to track income and expenditures. This information is required by the Internal Revenue Service in order to determine and assess the company’s tax liability. The final number of each journal entry is a debit amount in one account and a credit amount in another account. The total of the debits and credits in all equal transactions must be equal. Each journal entry is complete when this balance is achieved and is otherwise considered incomplete. A trial balance determines the amount of all completed and incomplete transactions. Transactions are considered balanced once they are complete.

5. The Role of Debit and Credit in Decision Making

Debit and credit are integral parts of the accounting process and all accounting information. S. Coseriu emphasizes that history gives meaning and expands our understanding. By examining the end of a cycle and working backwards, we can establish meaningful content and organize our procedures. History becomes a framework for comprehending relationships and a matrix for future actions. Debit and credit concepts have a historical foundation and are scientifically grounded components of accounting processes. They form the basis for analytical activities and managerial decision-making methods. The evaluation unit for amounts (money) and the cumulative debit and credit summaries in the accounting department provide practical experiences that serve as an encyclopedia of accounting. Debit and credit have been used in practical work for many years, and professionals have been trained to accurately interpret this data.

The role of debit and credit in decision making is significant. Every decision we make is a choice to move in a specific direction, which brings both positive and negative prospects or forecasts. Some challenges are tangible and individual, while others must be considered collectively. It has long been recognized that financial matters, particularly cash and resources, drive business operations. Financial forecasts and decisions are fundamental components of organizational activities, rooted in accounting theory and serving as executive tools. This is evident in the use and explanation of debit and credit.