The Accounting system works on the double entry system. Double entry system is very simple according to which an accounting transaction affects two accounts. If one account increases the another one must decrease or apparently a liability must arise. In accounting language, it is known as when one account is debited another one gets credits.
The term Debit and Credit was arrived from the study of Luca Pacioli in 1494. She used the terms ‘Debere’ and ‘Credere’. Debre meant ‘to owe’ whereas Credere meant ‘to entrust’. These were Latin words. Debere is used as Debit (Dr) and Credere is used as Credit (Cr). Debit and Credit form the vital part of the accounts because they ensure the proper working of Book Keeping system. When one account is debited another one at the same time is credited with same amount. Thus the Trial Balance always tends to be equal in terms of Debit and Credit. If it does not match, then it means that there has got to be some error. Accountants use this trial balance for further formation of Accounts and Balance Sheet.
The Debit and Credit rule is basically based on the double entry system. It majorly takes into consideration the Accounting equation.
Assets = Owner’s Equity + Liabilities
This equation can be further expanded by introducing the Expenses and Income into the equation. After the introduction the statement stands like this:
Assets + Expenses = Owner’s Equity + Liabilities + Income i.e., Assets = Owner’s Equity + Liabilities + (Income – Expenses) Assets = Owner’s Equity + Liabilities ± Profit/Loss
1. Assets: Whenever the asset is put into business or any additional asset is introduced it gets debited. It’s a source for the business which is possessed by the business. If it gets depleted or reduced, then it is credited.
2. Liabilities: Liabilities are the obligations for the business i.e. business owes to the outsiders. This is a burden for the business. If a liability is increased, it gets credited and if the liability is decreased it gets debited.
3. Capital: Capital is also known as Owner’s Equity. It is the initial amount invested by the owner of the business in the business. This is treated as a liability in the business. If the additional capital is introduced, then it is debited. If any amount is withdrawn by the owner, it is debited.
4. Expenses: Expenses are the costs incurred by the business for day to day running of business. Whenever any expense is incurred it is debited.
5. Income: Income is the amount earned by the business from its business operations. Whenever any income is earned, it gets credited.
Debit and Credit have their own rules. These can be understood by two approaches:
1. Traditional Approach: Under Traditional Approach the debit and credit are taken over by understanding the basic types of accounts.
This approach works as further:
(i) Personal Account: Personal account are the assets that refer to some individual person. The rule for the personal Account is: Debit (Dr): The Receiver, Credit (Cr): The Giver.
(ii) Real Account: The Real account deals with the assets and liabilities of the business. The rule for Real Account is: Debit (Dr): What comes in, Credit (Cr): What goes out.
(iii) Nominal Account: The Nominal Account deals with the incomes, gains, expenses and losses. The rule for Nominal Account is: Debit (Dr): Expenses and losses, Credit (Cr): Incomes and Gains.
2. Modern approach: The modern approach is quite simple to understand. It is just like the study of the five elements of accounting.
It works as follows:
Debit and Credit are the basics of accounting on which the whole accounting procedure operates. It is a crucial part of accounting.
The debit and credit are very widely used these days in the banks in relation to plastic money i.e. Debit Card and Credit Card. Debit card means the card for which money has to be deposited with the bank first and then you get the privilege to spend it whereas in a Credit card you have the privilege to spend the money first and then you have to pay the amount to bank later. Debit and Credit here are used in connection to Asset and Liability.
Thus we see how Debit and Credit form an important part of the accounting system. They define the whole accounting system in a compact way.
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