Thursday, 30 May 2019

Debit and Credit for an Easy Understanding

Debit and Credit

Debit and credit have much importance when we try to learn the language of business. This language is known as Accountancy. A clear understanding of both debit and credit will give you a strong foundation in the journey of learning and practising of accounting.
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Before learning the term Debit and Credit, we need to understand the types of accounts existing in the business.

Types of Accounts in Business


In business, the number of transaction may be large and complex, but all these transactions affect many accounts like personal or impersonal accounts. 



Accounts


Account means a unique record in the books of accounts of the business used to record the monetary events. 'Cash Account' is an example.

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All these accounts are classified based on the two accounting approaches. 

They are 

  • Traditional Approach or British Approach and 
  • Modern Approach or American Approach






A. Classification of Accounts based on the Traditional Approach


Please find the chart below to understand the classification of accounts based on the traditional approach.

Classification of Accounts
Chart Showing Classification of Accounts

We need to have clear knowledge to clarify all these accounts. Let 's see it with examples.

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1. Personal Accounts

These accounts are relating to persons. Again it has divided into 3 categories.
  • Accounts of natural persons. (Joseph's Account, Krishna's Account)
  • Accounts of artificial persons. This account includes the accounts in the name of companies, firms, partnership etc. ( ABC Ltd., XYZ Pvt. Ltd., etc.)
  • Representative Personal Accounts represent the collective account of persons. ( Salary Payable Account, Rent Payable Accounts, etc. ).

2. Real Accounts

These are accounts belongs to the Assets of the business. They are further divided into two. They are 



  • Tangible Account
  • Intangible Account
Tangible Real Accounts are those assets which we can be seen and touched. In other words, these assets have a physical existence. Example: Building Account, Land Account, Machinery Account, etc.,

Intangible Real Accounts means those accounts that have no physical existence. But these assets can be measured in terms of money. Example: Patent Right Account, Goodwill Account, Intellectual Property Rights Account etc.

3. Nominal Accounts

These accounts relate to the Expenses or Income of the business. All accounts of losses and gains categorized under this group. Examples: Salary Account, Wages Account, Commission Received Account.


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Golden Rule of Accounting based on Traditional Approach


Golden rule of Accounting



Let us see an example.

(i) Mr A started a business with USD 100,000

To find the Debit or Credit, there three steps.
First of all, find the accounts associated with the transaction. 

When Mr A starts a business with USD 100,000, the transaction is associated with two accounts. One account is Cash or Bank A/c, and the other is A's Capital A/c.

Next step is to decide the type of accounts. Cash Account is a Real Account and the Capital Account is a Personal Account.

Finally, we can decide which account will be debited and credited. When the business started, the cash came to the business. So Cash Account is to be debited. (Real Account rule - Debit what comes to the business ). Capital Account is to be Credited ( Personal Account Rule - The Giver ). Mr A is given money to the business. As per Separate Entity concept, the business and its owners are separate.




Debit - Cash A/c
Credit - Capital A/c


(ii) Purchased goods for cash USD 5,000

Here, the accounts are Purchases A/c and Cash A/c.
Purchases a/c is a Nominal Account and Cash A/c is a Real Account. then the Debit is Purchases A/c ( Nominal Account Rule - Debit all Expenses or losses), Credit Cash A/c ( Real Account Rule - Credit what goes out of the business ).

When we purchase goods, expense incurs as purchases and the cash goes out of the business.

Debit - Purchases a/c
Credit - Cash A/c


(iii) Paid rent USD 100

Two accounts associated with this transaction are Rent A/c and Cash or Bank A/c.
Rent A/c is to be debited ( Nominal Account Rule - Debit all Expenses and Losses ) and Cash A/c is to be Credited ( Real Account Rule - Credit what goes out from the business ).

Debit - Rent a/c
Credit - Cash A/c


B. American Approach or Modern Rule of Accounting 





In this approach, the transactions divided into five categories. They are transactions for Assets, Liabilities, Capital, Income and expenses.

Rule of credit and debit for these transactions mentioned in the table shown below.

Type of Account Debit Credit
Asset Increase Decrease
Liability Decrease Increase
Capital Decrease Increase
Revenue Decrease Increase
Expense Increase Decrease



As per this approach, Assets and Expenses accounts are showing the same effect when a transaction hit these accounts. Liabilities, Capital and Revenue accounts are reflecting the same changes when these accounts affect. 

Let us see the same examples.

(i) Mr A started a business


Accounts Effect on Account Debit / Credit
Cash A/c Increase in Cash Debit
Capital A/c Increase in Capital Credit

(ii) Purchased Goods for Cash


Accounts Effect on Account Debit / Credit
Purchases A/c Increase in Stock Debit
Cash A/c Decrease in Cash Credit

(iii) Paid Rent


Accounts Effect on Account Debit / Credit
Rent A/c Increase in Expense Debit
Cash A/c Decrease in Cash Credit

These are the basic terms and concepts of accounting. Any student who pursues a commerce or finance course including Chartered Accountancy or Cost and Management Accountancy course should start from these concepts. A clear understanding of these concepts is required one to move through the language of business and to more complicated areas.

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We hope you understand the concept well. You can comment to me if you need any clarification or suggestions. Request you to share it with others if you feel this article may help them.




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