In accrual accounting, a double
set of entries is required. For
every single transaction, two
accounting entries are made: a debit
and a credit. In its simplest form,
an account has only three elements:
A title, consisting of the
name of the particular asset,
liability, shareholder’s
(owner’s) equity, revenue, or
expense;
A left side, which is called
the debit side; and
A right side, which is
called the credit side.
This form of account is called a
T-account given its resemblance to
the letter T.
An amount recorded on the left
or debit side of an account is
called a debit, or a debit entry. An
amount on the right or credit side
is called a credit, or a credit
entry. The act of recording a debit
in an account involves debiting the
account; the recording of a credit
involves crediting the account. A
debit to an account is also
sometimes referred to as a charge to
the account. An account is therefore
debited or charged when an amount is
entered on the left side of the
account.
Often, people have erroneous
notions about the meaning of the
terms debit and credit. For example,
the word credit may carry a
favourable connotation and the word
debit may be associated with debt.
Such connotations have no validity
in the accounting profession.
The dollar difference between
total debits and total credits in an
account is the balance. If the
debits exceed the credits, the
account has a debit balance; if the
credits exceed the debits, the
account has a credit balance.
In an asset account such as
cash, increases are recorded on the
left or debit side of the account
and decreases are recorded on the
right or credit side. This custom
reflects the fact that a common
format for a balance sheet shows
assets on the left side of the
balance sheet. All asset accounts
normally have debit balances; that
is, increases are greater than
decreases. It is hard to imagine an
account for an asset such as land
having a credit balance, as this
would indicate that the business had
disposed of more land than it had
acquired and had reached the
impossible position of having a
negative amount of land.
Increases in liability and
owners’ equity accounts are recorded
by credit entries with decreases
recorded by debits. The relationship
between entries and their position
on the balance sheet may be summed
up as follows:
Liability and owners’ equity
accounts normally have credit
(right-hand) balances.
An increase in a liability
or shareholder’s (owner’s)
equity account is recorded on
the right (credit) side of the
account.
Since revenues increase and
expenses decrease the owner’s
equity, the rules of debit and
credit for recording revenue and
expenses logically follow this
relationship. Applying this rule to
revenue and expenses, the following
results are obtained:
Revenue increases owner’s
equity; therefore, revenue is
recorded by a credit.
Expenses decrease owner’s
equity; therefore, expenses are
recorded by debits.
Every business transaction
affects two or more accounts. The
double-entry system takes its name
from the fact that equal debit and
credit entries are made for every
transaction. If only two accounts
are affected, as in the purchase of
a computer for cash, the asset
account called COMPUTER is debited
and another asset account CASH is
credited for the same amount. If
more than two entries are affected
by a transaction, the sum of the
debit entries must be equal to the
sum of the credit entries. Recording
equal amounts of debits and credits
for each transaction ensures that
the balance sheet equation of Assets
= Liabilities + Owner’s Equity will
always be in balance.
The double entry system is based
on the principle of exchange, i.e.,
every business transaction involves
two considerations: value received
and value given. For simplicity, in
the case of an asset, value received
is a debit (DR ) and value given is
a credit (CR ). Therefore, if a desk
is purchased for $500 cash, two
things occur:
A desk worth $500 represents
a debit.
$500 paid for the desk
represents a credit.
Thus, all transactions are
expressed by means of a debit and a
credit and, at all times, the total
of debits and the total of credits
are equal. Before financial
statements are prepared, a trial
balance is completed to ensure the
equality of debit and credit
entries, i.e., that the total of all
accounts with debit balances is
equal to the total of all accounts
with credit balances.
The T-account is convenient for
illustrative purposes as it provides
a conceptual picture of the elements
of a business transaction. In formal
accounting records, more information
is needed, e.g., the date and
explanation of the transaction. The
T-account is replaced by the
traditional ledger account.
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