Sunday, 11 April 2010

Accountants Need to Know Their Debits and Credits

Accounting career seekers have to be very clear about the basic rules that determine when an account should be "debited" and when it should be "credited". One fundamental rule of double entry bookkeeping is that total debits must equal total credits. Every business transaction is recorded by one or more debits and one or more credits, and the total of debits will equal the total of credits.

In the posts so far, we have discussed what an account is, the types of accounts and accounting procedures. We saw that all business transactions have two aspects, i.e. receiving and giving of value. It is this dual aspect that is reflected by debits and credits.

In this post, we tie things together by looking at the rules for debit and credit. An account can have a debit or credit balance depending on whether the total of debits exceeds the total of credits in that account or whether it is the other way round.

As we mentioned earlier, accounts are classified broadly into Income, Expense, Asset, Liability and Equity accounts. It will be easier to remember the debit and credit rules if we look at each type of account separately.

Income Account Debits and Credits: An income account is CREDITED if a business transaction has the effect of INCREASING that INCOME. If a transaction results in reducing income, the affected income account is debited.

Expense Account Debits and Credits: An expense account is DEBITED if a transaction INCREASES that EXPENSE, and credited if the transaction reduces the expense.

Asset Account Debits and Credits: If a transaction INCREASES an ASSET, the asset account is DEBITED, and if it reduces the asset, the amount is credited.

Liability Account Debits and Credits:  Transactions that INCREASE a LIABILITY are CREDITED and reductions in liability are reflected through a debit to the concerned liability account.

Equity Account Debits and Credits: Owners' EQUITY INCREASES are recorded through CREDITS and reductions are reflected through debits to relevant equity accounts.

If you remember the above rules, you should have little difficulty in deciding whether to debit or credit an account (provided you know to which category a particular account belongs to).

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