Debit and credit are formal bookkeeping and accounting terms. They are the most fundamental concepts in accounting, representing the two records that one party in a transaction makes on its records, transferring a money balance from one account to another, one representing a reduction of liability or increase in asset, and the other representing a balancing increase in liability or reduction of asset.
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In accounting theory, the financial aspects of an entity, stated in terms of units of currency, are calculated using the accounting equation which is that Capital (or Equity or Net Worth) equals the value of your Assets (things you own) less the value of your Liabilities (things you owe); this is more often rearranged as: Assets equal Liabilities plus Capital. Each Asset, Liability and Capital account contains debit and credit transactions that allow for the calculation of values for these accounts.
Debits and credits are a system of notation used in accounting to keep track of money movements (transactions) into and out of an account: money paid into an account is a debit, money taken out of an account is a credit. Traditionally, an account's transactions are recorded in two columns of numbers: debits in the left hand column, credits in the right. Keeping the debits and credits in separate columns allows each to be added up independently so that the total debits and credits can be calculated; the smaller of the two totals is then subtracted from the larger to get the account balance. If an account has a debit balance then it owes money (to someone) because more money has been paid into it than has been drawn out, if it has a credit balance then it is owed money. Some accounts would normally have a credit balance because money usually only ever comes out of them (a salary account for instance), some normally a debit balance (a weekly shopping expense account, car fuel account).
What is often confusing is that the notion of debit and credit will depend on the perspective of the person preparing the accounts, even though they may be essentially the same account. Take your bank account for example. In your accounts when you pay money into your bank account it is recorded as a debit, your bank account is in debt to you - the bank owes you money. The bank's perspective is different however, their job is to keep track of where all the money in their 'vault' has come from and where it goes. To do this, they create an account for each customer so when you pay money into the bank, from their perspective, it has come out of your account (a credit) into their vault: your account is in credit - your account is owed money. When you receive a statement from your bank, it will give the state of your account from the bank's point of view, which is why people are used to the term 'your account is in credit' to mean that they have money in that account, when technically it means the opposite.
The two column system was developed in the days when accounts were done manually, and it is simpler and less error prone to add all the numbers in a column and then take the difference between the two results; but that is not the only reason it is used. In the double entry bookkeeping system, transactions never occur in isolation; money always moves from one account (credit) to another (debit): from your salary account to your bank account, from your bank account to your mortgage account, from your credit card account to your car fuel account, ... This means that each credit transaction must have a balancing debit transaction and that the sum of all credits in the accounts must equal the sum of all debits, if not, an error has been made; keeping separate debit and credit columns makes it much easier to check this. It is also very useful to analyse the cashflow of an account (where money came from and where it went), and again, the two column system makes it much easier to see this.
Computer accounts systems also normally use the double entry bookkeeping system and often present the accounts in the same two column system or a bank statement type format, do cashflow analysis, etc. Internally though, they would not usually use a two column system for an account but positive and negative numbers instead. Indeed, that is a convention (debits are positive, credits are negative) that goes back to the computer programming language COBOL.
The accounts are collectively referred to as the ledger. A journal is a place where entries (debits and credits) are written before they are written in the ledger. Modern computer systems generally have you make entries directly to the ledger and then produce printouts that are designed to look as if they were journals, which they may not be in reality. Of course, the computer software you are using will have a built-in feature to make sure your debits equal your credits, which is one of the chief benefits of old-fashioned journals anyway. For each transaction, one or more accounts are debited, and one or more accounts are credited. The total value of the debits must equal the total value of the credits. A debit journal increases the balance on a debit value account and reduces the balance on a credit value account. A credit journal increases the balance on a credit value account and reduces the balance on a debit value account.
In an asset account, a debit entry signifies the receipt of new assets, and thus represents an increase in assets. In a liability account, a debit entry represents a sum to be applied toward the satisfaction of the liability, and therefore decreases the liability.
There are different types of accounts and these accounts are expected to hold either a debit balance or a credit balance. Asset accounts and expense accounts are expected to always have a debit balance. Gain, Income and Liability Accounts are expected to always have a credit balance.
The terms Debit and Credit have Latin roots. Debit comes from debere, which means "to owe". The Latin debitum means "debt". Credit comes from the Latin word credere, which means "to believe" or "to entrust". It is more common to use the plural terms "Debits" and "Credits".
Historically the Debit side of an account is the left hand side of a general ledger account, while the Credit side of an account refers to the right hand side.
The concepts of 'positive' and 'negative' are different from those of 'credit' and 'debit'. While it is true that an asset account having a debit balance is in receipt of more credits than it has issued and has positive value to the entity being tracked, and a liability account having a credit balance has extended more credit than has been repaid and has a negative value to the entity being tracked, not all accounts carrying a credit balance are liabilities nor are all accounts carrying a debit balance assets. For example revenue accounts usually extend credit to asset accounts, but these credits do not have to be repaid, so they are not liabilities. As another example, expense accounts, having received credits from other asset accounts to pay expenses, carry a debit balance, but are not considered assets. The distinction between "real" accounts and "nominal" accounts is that "nominal" accounts are accounts in which to record changes in the equity or net worth. These are the revenue and expense accounts and should be thought of as a variety of equity accounts (recording how much the "entity" owes, in a sense, to the owner(s)).
Computers have no concept of "left" and "right", so instead, computer accounting systems use negative numbers to represent credits, and positive numbers to represent debits. This makes sense because a debit entry represents an inflow into an account and a credit entry represents an outlay from an account, but can seem counterintuitive until one recognizes that the receiving account is the nominal debtor and the distributing account is the nominal creditor. For example, a credit (negative value) is recorded in sales account in order for the receipt of the sale amount to be recorded as a debit (positive number) in an asset account.
If the value of the debits is greater than the value of the credits, then the balance on the account is a debit balance and should not be described as a positive value balance, but should be described as an account with a debit balance.
Debit can be abbreviated as Dr., while credit can be abbreviated as Cr.
Debits and Credits are recorded in a T account as shown below
| Debits | Credits |
|---|---|
Debit entries are made on the left side of the vertical line and credit entries are made on the right side of the vertical line.
Debits and credits are neither positive nor negative values. The balance on an account is either a debit or a credit, not a positive or a negative value. Dividend, Expense, Asset and Losses (abbreviated as "D-E-A-L") accounts increase in value when debited and decrease when credited, whereas Gains, Income, Revenues, Liability and Stockholder's (Owner's) equity (abbreviated as "G-I-R-L-S") accounts decrease in value when debited and increase when credited.
This distinction is somewhat counterintuitive, until the nature of those accounts is more closely scrutinized. For example, revenue is coded as a credit. After recording a day's sales invoices, the company will have credited a certain amount in revenue, but the customer's ledger will hold a debit balance being the amount of the unpaid invoices. To fully understand this see Double-entry bookkeeping system where Debits and Credits form the core of that system.
For instance, the journal entry for paying the telephone bill might look like this:
| Description | Debits | Credits |
|---|---|---|
| Phone expense | $200 | |
| Cash | $200 |
The telephone company would record the exact same transaction (from their side) like this:
| Description | Debits | Credits |
|---|---|---|
| Cash | $200 | |
| Revenue | $200 |
Confusion also arises where the term debit is also informally referred to as a "charge" as in a charge card or a debit card and that credit is a limit set or an amount granted by a company to its customers as in a credit limit. They are used in a different context in these two cases.
It is often assumed that a debit decreases a balance, and a credit increases it, because this is how the terms are shown on bank statements and using a debit card decreases the balance in one's bank account. However, this is because bank statements are traditionally written from the bank's perspective, where the customer's account is a liability. By withdrawing money, the customer is decreasing the bank's liability. Since liability accounts normally have a credit balance, the withdrawal of cash from a banking account is reflected on the bank's balance sheet as a debit.
All the account heads used in Accounting systems are classified under two types of Accounts i.e. Real Account and Nominal Account.
Real Account: Debit what comes in, Credit what goes out.
Nominal Account: Debit all expenses/losses, Credit all incomes/gains [1]
An account for a building you own (an asset) could be thought of as representing how much the building owes you (or the entity, if you prefer) for future building services (shelter, etc.). In that sense, all accounts, even those pertaining to inanimate objects, could be thought of in the same way as "persons" .
Personal Account: Debit the Receiver/Sundry Debtor, Credit the Giver/Sundry Creditor.