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Amity Business School

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Meaning of Debit and Credit

In actual practice, the individual transactions of like nature are recorded, added and

subtracted at one place. Such place is customarily termed as an Account. Prior to

understanding the meaning of debit and credit, it is essential to understand the

meaning and form of an account.

An account is a ledger record in a summarized form, of all the transactions that

have taken place with the particular person of things specified

- Carter

All accounts are divided into two sides. The left side of an account is arbitrarily or

traditionally called Debit side and the right side of an account is called Credit side.

In the abbreviated form, Debit is written as Dr. and Credit is known as Cr.

Debit (Dr.) Cash Account Credit (Cr.)

The above account is often called T shape account. An account is abbreviated as A/c.

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Capital Account: Decrease in capital will be recorded on debit side and increase in capital

will be recorded on credit side.

Revenue or Income Accounts: Decrease in gains and incomes will be recorded on debit

side and increase in gains and incomes will be recorded on credit side.

Losses or Expenses Accounts: Increase in losses and expenses will be recorded on debit

side and Decrease in losses and expenses will be recorded on credit side.

Traditional Approach: Traditional approach is also known as Double Entry System.

According to this system every business transaction affects at least two accounts in opposite

directions. For example, if the furniture is purchased in the business, furniture is increased

whereas the cash is decreased. There can be no transaction in the business which affects only

one account or which has only one aspect. As such, both the aspects of every transaction are

recorded under this system. It may, however, be noted that the double entry does not meanthat a transaction is recorded twice. But it means that at least two accounts are affected by a

transaction one account receiving a benefit and the other account yielding a benefit. The

person or the account receiving a benefit is debited and the person or the account who gives

something to the business is credited. The amount of every transaction is written twice, once

as a debit and again as a credit. E.g. We received Rs. 5,000 from Mohan. Here cash account is

receiving, hence debited whereas Mohan is yielding, hence credited.

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Recording of dual aspects of business transactions in terms of Debit and Credit is

known as Double entry system of accounting

This system of accounting was invented by Lucas Pacioli of Italy in 1494 in Venice

but developed in England.

Characteristics of Double Entry System

Every business transaction affects two accounts

Every account is divided in two parts

Based on Accounting concepts and conventions

Preparation of Trial Balance and Final Accounts

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Classification of

Accounts

Impersonal AccountPersonal Account

Natural Artificial Representative Real Accounts Nominal Account

Tangible Intangible

Personal Account: The accounts which relates to an individual, firm, company or an

institution are called personal account. Account of Mohan, account of Ram Chander, KrishanChander, Account of D.C.M. Ltd, Account of Delhi University, Bank Account, Capital Account

of the proprietor, Drawing account of the proprietor etc.

Rule: Debit the receiver and Credit the giver

In other words, Debit that persons account who receives something from the business and

Credit that persons account who gives something to the business"

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Example 1: Paid Rs. 1,000 to Hari:

In this case two accounts affected are Haris A/c and Cash A/c. Haris account will be

debited as he is the receiver of cash, the account of cash will be credited, as cash

has gone out and the entry will be:

Hari (Debit the receiver) Dr. 1, 000

To Cash A/c 1, 000

Example 2: Received Rs. 500 from Mohan:

In this case, cash account will be debited as cash has been received, and Mohans

account will be credited according to the rule of Credit the Giver. And the entry willbe:

Cash A/c Dr. 500

To Mohan (Credit the Giver) 500

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Types or Classification of Accounts

Natural Personal Account: Accounts of Natural Persons means the accountsof human beings. For example, Mohans A/c, Sohans A/c, Proprietors Capital A/c,

Proprietors Drawings A/c, Debtors A/c, Creditors A/c etc.

Artificial Personal Account: These accounts do not have physical existence ashuman beings but they work as personal accounts. For example, any Firms account,

any limited companys account, any institutions account and any other banksaccount. These are treated as artificial persons for the recording of business

transactions. These transactions also include the accounts of Clubs, Insurance

Companies and the accounts of Government departments which are recognized as

persons in the business dealings.

Representative Personal Accounts: When an account represents a particularperson or group of persons, it is termed as a representative personal account. Forexample, if the salaries for the month of December are not paid to the employees, the

amount payable to these employees will be added and put under one common title

Salaries Outstanding Account. This account represents the accounts of all the

persons to whom salaries have to be paid. This is therefore termed as

Representative Personal Account.

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Real Accounts: The accounts of all those things whose value can be measured interms of money and which are the properties of the business are termed as Real

Account. Such as Cash Account, Furniture Account, Machinery Account, BuildingAccounts, Goodwill Accounts etc.

Rule: Debit what comes in and Credit what goes out

In other words, whenever any property comes into the business, it is debited and

when it goes outside the business, it is credited.

For Example, if furniture for Rs. 5, 000 has been purchased for cash, furniture

account should be debited according to the rule of Debit what comes in, while cash

account should be credited according to the rule of Credit what goes out. And the

entry should be:

Furniture A/c (Debit what comes in) Dr. 5, 000

To Cash A/c (Credit what goes out) 5, 000

Types of Real Accounts:

Tangible Real Account: Accounts of the things which can be touched, felt,

measured, purchased and sold etc. E.g. Cash A/c, Furniture A/c, Land A/c etc.

Intangible Real Account: Accounts of things which can not be touched but, of

course, their value can be measured in term of money. E.g. Goodwill A/c, Trade MarkA/c, Patent A/c, Copyright A/c etc.

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Nominal Accounts: These accounts include the accounts of all expenses andincomes. E.g. Salaries paid, Rent paid, Discount Allowed and Bed Debts etc.

Rule:Debit the expenses and losses and Credit the incomes and gains

Example 1: Paid Rs. 5, 000 for Salaries.

In this case two accounts being affected are Salaries A/c and Cash A/c. Salaries

represents expenses and as such, Salaries account will be debited according to therule ofDebit the expenses. On the other hand, Cash A/c will be Credited according

to the rule of Credit what goes outand the entry will be:

Salaries A/c (Debit the Expenses) Dr. 5, 000

To Cash A/c (Credit what goes out) 5, 000

Example 2: Received Rs. 1, 000 for Commission.Commission A/c is a nominal account and represents an income. As such,

Commission A/c will be credited according to the rule ofCredit the incomes. Cash

A/c is a real account and cash is coming in, therefore Cash A/c will be debited

according to the rule ofDebit what comes in. And the entry will be:

Cash A/c (Debit what comes in) Dr. 1, 000

To Commission A/c (Credit the incomes) 1, 000

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Advantages of Double Entry System

Scientific System

Complete record of every transaction

Preparation of Trial Balance

Preparation of Trading and Profit & Loss A/c

Knowledge of financial position of the business

Knowledge of various information

Lesser possibility of fraud

Legal Approval

Comparative Study

Disadvantages of Double entry system of accounting:

Difficult to apply rules of debit and Credit

Only arithmetical accuracy of accounts is checked by preparing a trial balance under

the double entry system. Following types of errors are not disclosed:

Errors of Omission, Errors of Commission, Errors of Principle, and Compensating

Errors.

Disadvantages of Double Entry System

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Stages/ Parts of Double Entry System

Original Record: All the transactions are first recorded in a primary book calledJournal. When a business is a big one and the number of transactions is large,

journal is divided into various books which are called Sub-division of Journalor

Subsidiary Books. Thus recording in Journal or in its subsidiary books is the first

stage of double entry system. This stage is also known as Original record stage.

Classification: In this stage, all the transactions recorded in the Journal or itssubsidiary books are transferred (posted) in a classified form to another book which iscalled Ledger. This book contains, on different pages, individual account heads

under which all financial transactions of similar nature are collected at one place, so

that the combined effect of all the transactions relating to a particular account may be

ascertained. Posting in ledger is also known as Classification Stage.

Summary: In this stage, all the ledger are balanced off and are put in a list, debitbalances on one side and credit balances on other side. The list so prepared is called

a Trial Balance. With the help of Trial Balance a Trading and Profit & Loss A/c is

prepared to ascertain the profit earned of loss suffered during a particular period and

a Balance Sheet is prepared to show the financial position of the business.

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Books of Original Entry - Journal

The books in which a transaction is recorded for the first time from a sourcedocument are called Books of Original Entry. Journal is one of the basic books of

original entry in which transactions are originally recorded in a chronological (day-to-

day) order according to the principles of double entry system. When the size of the

business is a small one, then it is possible to enter each and every transaction in the

journal. But when the size of the business grows, it becomes no longer possible to

record each and every transaction in the journal. As such, the Journal is sub-divided

into a number of Sub-Journals known as special purpose subsidiary books orbooksof original entrysuch as: Cash Book, Purchase Book, Sales Book, Sales Return

Book, Purchase Return Book, Bills Receivable Book, Bills Payable Book, Journal

Proper.

Documents on the basis of which entries are recorded in the books of accounts are

named as source documents. The following are the most common source

documents:c) Cash Memo b) Invoice and Bill

d) Receipt d) Debit Note

e) Credit Note f) Pay-in-Slip

f) Cheque

Vouchers

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JOURNAL Journal is a book of original entry in which the transactions are recorded first of all, as

and when they take place.

The Journal as originally used, is a book of prime entry in which transactions are

copied in order of date from a memorandum or waste book. The entries as they

copied are classified into debits and credits, so as to facilitates their being correctly

posted, afterwards in the ledger

- Prof. Carter

Thus Journal provides a date wise record of all the transactions with details of the

account debited and credited, and the amount of each transaction. Prior to recording

in Journal, the transactions may also be recorded in a rough book called Waste book

or Memorandum book. Maintenance of waste book is not necessary but where the

number of every day transaction is so large that it is not possible for a businessmanto remember all of them, the use of waste book may prove helpful. Later on with the

help of waste book recording is made in Journal.

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Proforma of Journal

15

Date ParticularsLedger

Folio

AmountDr.(in Rs.)

Amount

Cr.(in Rs.)

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Example 1:

Enter the following transactions in the Journal of Siya Ram:

On 1st April 1994, following were the balances:

Cash in hand Rs.900, Cash at bank Rs.21000,Soni(Cr.) Rs.3000, Zahir(Dr)Rs.2400,Stock Rs.12000, Prasad(Cr.) Rs.6000, Sharma(Dr.) Rs.4500, Lall(Cr.)Rs.4500

1994 Rs. June 1 Siya Ram started business with cash 50, 000 2 Purchased goods for cash 20, 000 4 Purchased goods from Subhash 12, 000 5 Purchased furniture for cash 6, 000 7 Sold goods for cash 13, 000

9 Sold goods to Mahesh 15, 000 10 Paid cash to Subhash 8, 000 12 Received cash from Mahesh 10, 000 16 Purchased goods from Ravi for cash 7, 500

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June 17 Purchased goods from Ravi for cash 5, 000

18 Sold goods to Suresh for Cash 12, 600

19 Sold goods to Suresh 7, 000

20 Bought Machinery for Cash 8, 000

24 Withdrew cash from office for personal use 2, 500

27 Paid Rent 400

29 Paid Wages 450

30 Paid salary to Gopal 1, 20030 Received Commission 200

Different Entries:

Discount

Discount is of two types:

Trade Discount: The discount allowed by a seller to its customers at a fixed % on the

listed price of goods is termed as Trade discount. No separate entry is passed for the

trade discount, as it is deducted from the cash memo or invoice of goods.

Cash Discount: This discount is allowed to customers for making prompt payment.

As the discount is allowed at the time of making payment, so the entry for cash

discount is recorded along with the entry for payment. Discount is a nominal account

and an expense to the company, hence debited.

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Opening Entry

Every firm starts its new books in the beginning of each year. Since the closing

balances of last year have to be carried forward to the next year, the first entry ineach years journal will be recorded the previous years closing balances of all assets

and liabilities. As it is the first entry, is called the opening entry. In this entry the

accounts of all assets are debited because assets always show debit balances and

the accounts of liabilities and capital are credited because they always show credit

balances. In case the total of liabilities exceeds the total of assets, the difference will

be treated as the amount of Goodwill and the same will be debited in the openingentry.

Bad Debts

When the goods are sold to customer on credit, and if the amount becomes

irrecoverable due to his insolvency or for some other reason, the amount not

recovered is called bad- debts. For recording it, bad debts account is debited and thecustomers account is credited.

Bad Debts Recovered

Cash A/c Dr. 1, 000

To Bad Debts Recovered A/c 1, 000

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Started or commenced business with cash

Cash A/c Dr

To Capital A/c

Goods purchased from Mohan for cash

Purchases a/c Dr.

To Cash A/c

Goods purchased from Mohan

Purchases a/c Dr.

To Mohan A/c

Goods sold to Mohan for cash

Cash A/c Dr.

To sales A/c

Goods sold to Mohan on credit

Mohan A/c Dr.

To sales A/c

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Furniture purchased

Furniture A/c Dr.

To Cash A/c

Machinery sold

Cash A/c Dr.

To Machinery A/c

Salaries paid:

Salaries A/c Dr.

To Cash A/c

Rent received:

Cash A/c Dr.To Rent A/c

Amount received from Mohan, discount allowed

Cash A/c Dr. 990

Discount A/c Dr 10

To Mohans A/c 1000

Amount paid to Shyam, discount allowed

Shyam A/c Dr. 2000

To Cash A/c 1980

To Discount A/c 20

Depreciation on furnitureDepreciation A/c Dr.

To furniture A/c

Interest on Capital

Interest on capital A/c

To Capital A/c

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Outstanding Expenses

Salary A/c (or any other expense A/c) Dr. 1, 000

To Outstanding Salary A/c 1, 000

Prepaid Expenses

Insurance Premium (or any other expense A/c) Dr. 1, 200

To Cash A/c 1, 200

Mohan becomes bankrupt. A first and final composition of 40 paise in a rupee isreceived out of a loan of Rs. 2000 from official receiver

Cash A/c Dr. 800

Bad debts A/c Dr. 1200

To Mohan A/c 2000

An amount previously written off as bad debts has now been recovered from Mohan, theold debtor for Rs.700

Cash A/c Dr. 700To Bad debts recovered A/c 700

Expenditure on Installation of Machinery:

Machinery A/c Dr. 10, 000

To Cash A/c 10, 00

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Goods withdrawn

Drawings A/c Dr.

To Purchases A/c

Goods given away as charity

Charity A/c Dr.

To Purchases A/c

Goods distributed as free sample

Free Sample A/c Dr.

To Purchases A/c

Loss of goods by theft of loss by fireLoss by theft (fire) Dr.

To Purchases A/c

Recovery of Sales Tax

Cash A/c Dr.To Sales Tax A/c

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