Debits and credits are the building blocks of the double entry
accounting system. Many accounting students find the usage of these
words confusing. Many try to understand them by trying to draw an
analogy with something they already know like plus and minus. However,
debits and credits are distinctly different from plus and minus.
Sometimes a debit entry may make an account balance go up whereas other
times it will make an account balance go down. Let’s try and understand
how this debit and credit system works.
The debit credit system can be understood to be a two layered system. The steps involved in deciding whether an account needs to be debited or credited are as follows:
Similarly you can ascertain whether an item needs to be debited or credited. As a check, you must ensure that the debits in every transaction are equal to the credits. This is like the fundamental principle of accounting.
The debit credit system can be understood to be a two layered system. The steps involved in deciding whether an account needs to be debited or credited are as follows:
- Ascertain the type of account
- Ascertain the type of transaction
Ascertaining the Type of Account
Accounts are of two types the debit and the credit types. Here is how they are distinguished
- The 4 Classifications: There are four major classifications of accounts in accounting. They are assets, liabilities, income and expenses. Any item can be classified as exactly one of these classifications. However, the same item may be split into two and be part asset and part expense and so on.
- Divide into Two Groups: We could consolidate these 4 categories into 2 categories. Expenses and assets denote outflow of resources from the firm. Income and Liabilities denote inflow of resources to the firm. Thus accounts can be classified as outflow and inflow
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- The outflow accounts i.e. expenses and assets have a by default debit balance
- The inflow accounts i.e. income and sales have a by default credit balance
Ascertain the Type of Transaction
Now you can decide whether to debit or credit an account. Let’s say you have to increase the cash balance. Cash is an asset and therefore has a default debit balance. When you debit it further, you increase its balance. Therefore, you will debit the cash account.
Similarly you can ascertain whether an item needs to be debited or credited. As a check, you must ensure that the debits in every transaction are equal to the credits. This is like the fundamental principle of accounting.