Amity Business School

Amity Business School

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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Rules of Debit and Credit

 In order to decide when to write on the debit side of an account and when to write on the
credit side of an account. There are two approaches:
a) Modern approach and
b) Traditional approach
 Modern Approach:
“Debit means decrease in proprietor’ equity and credit means increase in proprietor’s
equity”
The rules of debit and credit depends on the nature of an account. For this purpose, all the
accounts are classified into the following five categories in the American approach:
I. Assets Accounts
II. Liabilities Accounts
III. Capital Account or Owner’s Equity Account
IV. Revenue or Income Accounts
V. Losses or Expenses Accounts
Assets Accounts: Increase in assets will be recorded on debit side and Decrease in assets will
be recorded on credit side.
Liabilities Accounts: Decrease in liability will be recorded on debit side and increase in
liability will be recorded on credit side.
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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 mean
that 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

Personal Account Impersonal 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, Krishan
Chander, 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 person’s account who receives something from the business and
Credit that person’s 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 Hari’s A/c and Cash A/c. Hari’s 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 Mohan’s
account will be credited according to the rule of “Credit the Giver”. And the entry will
be:

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 accounts
of human beings. For example, Mohan’s A/c, Sohan’s A/c, Proprietor’s Capital A/c,
Proprietor’s Drawings A/c, Debtors A/c, Creditors A/c etc.

• Artificial Personal Account: These accounts do not have physical existence as

human beings but they work as personal accounts. For example, any Firm’s account,
any limited company’s account, any institution’s account and any other bank’s
account. 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 particular

person or group of persons, it is termed as a representative personal account. For
example, 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 in
terms of money and which are the properties of the business are termed as Real
Account. Such as Cash Account, Furniture Account, Machinery Account, Building
Accounts, 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 Mark
A/c, Patent A/c, Copyright A/c etc.
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 Nominal Accounts: These accounts include the accounts of all expenses and
incomes. 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 the
rule of “Debit the expenses”. On the other hand, Cash A/c will be Credited according
to the rule of “ Credit what goes out” and 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 of “Credit 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 of “Debit 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

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.
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Stages/ Parts of Double Entry System

 Original Record: All the transactions are first recorded in a primary book called
Journal. 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 Journal” or
“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 its
subsidiary books are transferred (posted) in a classified form to another book which is
called “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, debit
balances 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 source
document 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 or books
of original entry such 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 businessman
to 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.
 Proforma of Journal
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Ledger Amount Amount

Date Particulars Folio Dr.(in Rs.) Cr.(in Rs.)

15
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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, 200
30 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 in
each year’s journal will be recorded the previous year’s 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 opening
entry.

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 the
customer’s 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 Mohan’s 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 furniture
Depreciation 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 is

received 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, the
old debtor for Rs.700
Cash A/c Dr. 700
To 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 fire

Loss by theft (fire) Dr.
To Purchases A/c

Recovery of Sales Tax

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