Double Entry Bookkeeping

In double entry bookkeeping, debits and credits (abbreviated Dr and Cr, respectively) are entries made in account ledgers to record changes in value resulting from business transactions. Generally speaking, the sources for spending money in transaction account is credit (that is, an entry is made on the right side of the account's ledger) and what the money obtained with thecredits is destined as debit in transaction accounts (that is, an entry is made on the left side). The credits here could also be share capital, revenues, etc. and The debits here could be assets, dividends, etc. From a technical point of view the sides refer to the balance sheet placement of accounts.[1] Totaldebits must equal total credits for each transaction; individual transactions may require multiple debit and credit entries to record.[2][3]
The difference between the total debits and total credits in a single account is the account's balance. If debits exceed credits, the account has a debit balance; if credits exceed debits, the account has a credit balance.[4] For the company as a whole, the totals of debit balances and credit balances must be equal as shown in the trial balance report, otherwise an error has occurred.
History[edit]
The first known recorded use of the terms is Venetian Luca Pacioli's 1494 work, Summa de Arithmetica, Geometria, Proportioni et Proportionalita (translated: Everything That Is Known About Arithmetic, Geometry, Proportions and Proportionality). Pacioli devoted one section of his book to documenting and describing the double-entry bookkeeping system in use during the Renaissance by Venetian merchants, traders and bankers. This system is still the fundamental system in use by modern bookkeepers.[5] It is also recorded that the Indian merchants had developed this art predating Pacioli's work known as "bahi-khata".[6]

One theory is that in its original Latin, Pacioli's Summa used the Latin words debere (to owe) and credere (to entrust) to describe the two sides of a closed accounting transaction. Assets were owed to the owner and the owners' equity was entrusted to the company. At the time negative numbers were not in use. When his work was translated, the Latin words debere and credere became the English debit and credit. Under this theory, the abbreviations Dr (for debit) and Cr (for credit) derive from the original Latin.[7] However, Sherman[8] casts doubt on this idea because Pacioli uses Per (Latin for "from") for the debtor and A (Latin for "to") for the creditor in the Journal entries. Sherman goes on to say that the earliest text he found that actually uses "Dr." as an abbreviation in this context was an English text, the third edition (1633) of Ralph Handson's book Analysis or Resolution of Merchant Accompts[9] and that Handson uses Dr. as an abbreviation for the English word "debtor." (Sherman could not locate a first edition, but speculates that it too used Dr. for debtor.) The words actually used by Pacioli for the left and right sides of the Ledger are "in dare" and "in havere" (give and receive).[10] Geijsbeek the translator suggests in the preface: 'if we today would abolish the use of the words debit and credit in the ledger and substitute the ancient terms of "shall give" and "shall have" or "shall receive," the personification of accounts in the proper way would not be difficult and, with it, bookkeeping would become more intelligent to the proprietor, the layman and the student.'[11]

Jackson[12] notes that "debtor" need not be a person, but can be an abstract operator (cf. "divisor" in math) "...it became the practice to extend the meanings of the terms ... beyond their original personal connotation and apply them to inanimate objects and abstract conceptions...".

Aspects of transactions[edit]
To determine whether one must debit or credit a specific account we use either the accounting equation approach which consists of five accounting rules[13] or the traditional approach based on three rules (for Real accounts, Personal accounts, and Nominal accounts) to determine whether to debit or to credit an account.[14]

Real accounts are the assets of a firm, which may be tangible (machinery, buildings etc.) or intangible (goodwill, patents etc.)
Personal accounts relate to individuals, companies, creditors, banks etc.
Nominal accounts relate to expenses, losses, incomes or gains.
Whether a debit increases or decreases an account depends on what kind of account it is. An increase to an asset account is a debit. An increase to a liability or to an equity account is a credit.

 Kind of account                Debit     Credit
Asset     Increase               Decrease
Liability Decrease             Increase
Income/Revenue            Decrease             Increase
Expense               Increase               Decrease
Equity/Capital    Decrease             Increase
Conversely, a decrease to an asset account is a credit. A decrease to a liability or equity account is a debit.

Debits and credits occur simultaneously in every financial transaction in double-entry bookkeeping. In the accounting equation—Assets = Liabilities + Equity—if an asset account increases (a debit), then either another asset account must decrease (a credit), or a liability or equity account must increase (a credit).

For example, when the customer of a bank deposits money into his bank account two things change: the customer's cash-in-hand (asset) decreases and the customer's bank account balance increases. The decrease in the cash-in-hand asset is a credit while the increase in the bank account balance is a debit of equal magnitude.

The bank views the transaction from a different perspective but follows the same rules: the bank's vault cash (asset) increases, which is a debit; the increase in the customer's account balance (liability from the bank's perspective) is a credit. A customer's periodic bank statement generally shows transactions from the bank's perspective, with bank deposits characterized as credits and withdrawals as debits.


Debits are traditionally entered on the left-hand side of a ledger and credits on the right-hand side.

Comments

Post a Comment

Popular posts from this blog

What is security?

A security is a tradable financial asset . The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some jurisdictions the term specifically excludes financialinstruments other than equities and fixed income instruments. In some jurisdictions it includes some instruments that are close to equities and fixedincome, e.g. equity warrants . In some countries and languages the term " security" is commonly used in day-to-day parlance to mean any form of financial instrument, even though the underlying legal and regulatory regime may not have such a broad definition. In the United Kingdom, the national competent authority for financial markets regulation is the Financial Conduct Authority ; the definition in its Handbook of the term "security"[1] applies only to equities, debentures, alternative debentures, government and public securities, warrants, certificates representing certain securities, units, st...
Read more

Do preferred stocks trade like common stocks?

The differences and similarities between common stocks and preferred stocks are numerous. Both represent a piece of ownership in a company, and both are tools investors can use to try to profit from the future successes of thebusiness. The main difference between the two types of stock is that holders of common stock typically have voting privileges , whereas holders of preferredstock do not. However, preferred stockholders receive a fixed dividend from the company, while common shareholders may or may not receive one, depending on the decisions of the board of directors. When valuing common and preferred stocks, an investor must consider the different properties of each type. Common stock may not offer the possibility of dividends, but generally investors will hold this type of stock because they are expecting to capture profit through a capital gain, or an increase in the stock price. Preferred stockholders, on the other hand, are generally interested in receiving a ...
Read more

What is 'Accounting'

Accounting is the systematic and comprehensive recording of financial transactions pertaining to a business , and it also refers to the process of summarizing, analyzing and reporting these transactions to oversight agencies and tax collection entities. Accounting is one of the key functions for almost any business; it may be handled by a bookkeeper and accountant at small firms or by sizable finance departments with dozens of employees at large companies. BREAKING DOWN 'Accounting' The reports generated by various streams of accounting, such as cost accounting and management accounting , are invaluable in helping management make informed business decisions . While basic accounting functions can be handled by a bookkeeper, advanced accounting is typically handled by qualified accountants who possess designations such as Certified Public Accountant (CPA) in the United States, or Chartered Accountant (CA), Certified General Accountant (CGA) or Certified Management A...
Read more