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Managing a Business
Managing a Business
Managing your Finances:
Debits and Credits
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Debit and Credit are the two parts of any business transaction. A 'business transaction' can be defined as an economic activity of the business that affects the financial position of the business. Purchase and sale of goods; expenses incurred on salary,rent,telephone; purchase of fixed assets and loans taken,etc are the examples of business transactions. The term 'Debit' means 'to owe'. A company having debit to its name means that it owes to others. Similarly,a company having 'credit' to its name means that others owe to it.

All the business transactions of a company are recorded in a general ledger account. A 'general ledger account' is the main accounting record of a business in which the financial transactions are represented by means of the two entries i.e. debit and credit. These terms are generally used as plurals in the accounting terminology and are abbreviated as Dr.and Cr.respectively.

In a general ledger account:-

  • Debits may be reflected in these forms:-

    • As various heads of expenses:- Expense is the amount spent by a firm in order to produce and sell the goods and services. For example,payment of salaries and wages.

    • As Debtors:- are the individuals who owe money to the firm on account of purchasing the goods on credit and have to pay the price in future.

    • As Assets:- Assets are the things of value owned. It includes everything that enables the firm to get cash or a benefit in future. For example, cash and bank balances, stocks, plants and machinery, buildings, patents, prepaid expenses,receivables,investments,etc.


  • Credits may be reflected in these forms:-

    • As various heads of receipts(revenue):- Receipt is the amount received by the firm from selling its goods and services. For example, receipts from sales, rent, etc.

    • As Creditors:- are the individuals to whom the firm owes money.

    • As Liabilities :- Liabilities are the debts which the firm owes to the outsiders. In other words, the claims of those who are not owners are called liabilities. For example, loans and advances, bank borrowings or outside borrowings, payables,etc.

    • As Equity:- Equity means the amount which the proprietor has invested in the firm or can claim from the firm. For the firm, it is a liability towards the owner.

In the general ledger account, all the debit entries are recorded on the left hand side, while, the credit entries are recorded on its right hand side. The ledger accounts are set up as T accounts so called because they resemble the letter T when the account is empty.

A general ledger is generally classified into three accounts called, personal account, real account and nominal account. The basic rules of accountancy for debits and credits based on this classification of accounts are:-

Rules relating to Personal Accounts:-

Personal accounts are the accounts which are related to persons (individuals, firms, companies, etc). Accounts of the debtors, creditors, and the capital account of the proprietor are examples of personal accounts. Such an account shows the amount of money that the firm owes to the creditors and the amount it can recover from its debtors.

The rules for debits and credits of this account are:-

  • Debit the receiver:- receiver of the amount is debited. For example, in case of payment to a dealer, the payment made to him is debited.

  • Credit the giver:- the one who gives the amount is credited. For example, in case of receipts from the customers,the customer giving the payment is credited

Rule relating to Real Accounts:-

Real accounts are the accounts which are related to the assets of the firm. For example, land, building,investment, cash,etc. Such an account shows the value of properties as well as the stocks of the firm.

The rules for debits and credits of this account are:-

  • Debit what comes in:- The receipt of goods is debited. For example,if a firm purchases machinery, these purchases are debited as stocks coming in.

  • Credit what goes out:- The sale of goods is credited. For example,if a firm sells its goods,these sales are credited as goods going out

Rule relating to Nominal Accounts:-

Nominal accounts are the accounts which are related to the expenses, losses, gains and revenue, etc. The sales account, interest account, salary account are the examples of nominal accounts. Such an account reflects the sources of income and also the amount spent on various items.

The rules for debits and credits of this account are:-

  • Debit all expenses and losses:- All cash payments in the form of expenses and losses are debited. For example, payments for salaries,rent and losses are debited.

  • Credit all incomes and gains:- All cash receipts in the form of incomes and gains are credited. For example, receipts from sales ,income earned, profits from sales are credited

After posting the accounts in the ledger, a statement is prepared to show separately the debit and credit balances. Such a statement is known as 'Trial Balance'. The Trial Balance is prepared by listing each and every account of the ledger and entering in separate columns the totals of the debit and credit sides. The two columns are separately summed up and compared. The totals so obtained must be equal. If they are not equal,that would mean that these entries are out of balance and something is amiss somewhere. Thus,it helps to check the arithmetical accuracy of the entries.

This exercise of recording the business transactions based on the principles of accountancy helps in ascertaining the financial position of the firm. It indicates the expenses and earnings of the firm as well as the amount of its debits and credits. It also reflects the long term sustainability of the firm's profits and its growth prospects. Hence, maintaining such accounts form an essential part of a company's financial management.

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