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Debits and Credits Explained

by Wise Accounts on 27 Jun 2013 permalink
Debits and credits are a system of notation used in bookkeeping to determine how and where to record any financial transaction. In bookkeeping, instead of using additions '+' and subtraction '-' symbols, a transaction uses the symbol DR (Debit) or CR (Credit). In double-entry bookkeeping debit is used for asset and expense transactions and credit is used for liability, gain and equity transactions.

For bank transactions, money received in is treated as a debit transaction and money paid out is treated as a credit transaction. Traditionally, transactions are recorded in two columns of numbers: debits in the left hand column and credits in the right hand column. Keeping the debits and credits in separate columns allows each to be recorded and totalled independently. Where the total of the debit value amounts is lower than the total of the credit value amounts, a balancing debit value is posted to that nominal ledger account. That nominal ledger account is now "balanced". An account can have either a credit value balance or a debit value balance but not both.

A debit can also be used to reduce the balance on a liability, gain and equity account. This has the effect of reducing a credit balance by the value of the debit transaction. The balance in a nominal that is normally expected to hold a debit balance may change from a debit balance to a credit balance.

A credit can also be used to reduce the balance on an asset or expense account. This has the effect of reducing a debit balance by the value of the credit transaction. The balance in a nominal that is normally expected to hold a credit balance may change from a credit balance to a debit balance.

In some cases such as fixed assets, all debit transactions will be recorded in one nominal account and all credit transactions will be recorded in a contra nominal account, with the exception when an asset is disposed of. The purchase of an asset will be recorded in a fixed asset account (debit transaction) and the depreciation of the fixed asset (credit transaction) will be recorded in a contra nominal ledger account, fixed asset depreciation.

Each transaction consists of debits and credits, and for every transaction they must be equal.

For Every Transaction: The Value of Debits = The Value of Credits

The extended accounting equation must also balance:
A + E = L + OE + R

(where A = Assets, E = Expenses, L = Liabilities,
OE = Owner's Equity and R = Revenues)

So Debit Accounts (A + E) = Credit Accounts (L + R + OE)

Debits are on the left and increase a debit account and reduce a credit account.

Credits are on the right and increase a credit account and decrease a debit account.


Therefore, if an Asset account is debited, the Asset amount (value) is increased. Same with an Expense account. If a Liability or an Income account is debited, the numerical figure will decrease, etc. If a particular account is credited, there must be a corresponding Debit in another account in order to balance the transaction.

As used in banking terminology, 'Debits" refer to withdrawals, not necessarily in the same context as discussed here.

So to wrap it all up you can remember all of this with the mnemonic phrase: "Accountants are credited for being afraid of negative numbers."

Suzie Wilson says:
At last I get it! Thanks for that article...



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