Debits, credits and the double entry accounting are techniques associated with Luca Pacioli; a former Franciscan monk. Referred to as the â€˜Accounting Father’, he cautioned than one should not go to bed before your debits equals your credits. Pacioli’s book keeping method reveals that in a ledger or balance sheet, assets=liabilities +owner’s equity. If there is an increase in assets’ value, this is a debit to the account while a decrease in assets value is a credit. On the other hand, where there is an increase in the owner’s equity or increase in liabilities, this is a credit to the account while a decrease is regarded as a debit.
Debits and credits have their origin roots from Latin. Debit is from the phrase â€˜debitum’ meaning â€˜what is due’ while credit if from the phrase â€˜creditum’ meaning a loan or something which has been entrusted to another person. Therefore, when assets are increased, the change in accounts is a debit since something has to be due in order to necessitate that increase (the asset’s price). Equally, increase in liabilities is a credit as it signifies an amount entrusted to somebody else or loaned to you which was used for purchasing something. The cause of this loan is an asset which is a corresponding debit in the column of assets.
Notations of DR as debits and CR as Credits
Few theories explain why debits are abbreviated as DR and credits as CR. One theory asserts that DR stands for debit record while CR stands for credit record. Others believe that DR is the short form of debtor while CR is the short form of creditor. The approach devised by Pacioli is the contemporary basis used in accounting today. Through the use of credits and debits, individuals and companies are now able to keep track of their transactions and also manage their finances.
Accounting Application of Debits and Credits
In order to track finances properly, it is very important for small businesses to make use of an accounting system. The use of debits and credits is a tool of paramount importance in a system of accounting. In a journal entry, accountants make use of debits and credits to change the amount of money in any account. Depending on the account type that is to be credited or debited, the account may decrease or increase. The main factor which determines the difference between debits and credits is the account type. It is also good to keep in mind that for every journal entry, the debited amount equals the credited amount.
Normally, a debit usually increases an asset’s account while a credit decreases the account of an asset. For instance, if $ 20,000 cash is debited and $ 20,000 is credited for accounts receivables, it means that there is an increase of $ 20,000 in cash and a decrease of $20,000 for accounts receivables.
Credits increase liabilities while debits reduce liabilities. For instance, when $ 20,000 is paid for accounts receivables through cash, the accounts payables will decrease by $ 20,000. The journal entry is to debit purchases by $ 20,000 while accounts payable will be increased by $ 20,000 for covering the purchase costs.
Included in income accounts are gains, revenues, expenses and losses. When income account is debited, an expense or loss is increased. On the other hand, when an income account is credited, gains or revenues are increased. For instance, when a company sells equipment at a loss for cash, loss on equipment would be debited; cash would also be debited while Equipment would be credited. As stated previously, when cash is debited, this shows an increase in cash since the company has received cash. When Equipment is credited, it shows that there is a decrease in assets as the asset will have been sold.