Debit Credit Analysis

What Is Debit Credit Analysis?

Debit credit analysis is a fundamental aspect of accounting practices, integral to the role of accountants in maintaining accurate financial records.

With business transactions occurring regularly, accountants are tasked with recording these transactions carefully to assess their impact on the overall financial health of the enterprise.

This involves categorizing transactions into debit and credit entries, where debits are recorded on the left side and credits on the right side of an account.

Debit and credit entries serve as important components in the accounting process, allowing businesses to track the flow of funds into and out of their operations.

They form the cornerstone of the double-entry system, where each transaction involves equal and opposite entries in the debit and credit columns, ensuring a balanced representation of financial activity.

How Debit and Credit are Used

Debits and credits have a broad impact on the various types of accounts, which are explained below:

• Assets: It is increased by debit and decreased by credit

• Expenses: It is increased by debit and decreased by credit

• Liabilities: It is increased by credit and decreased by debit

• Equity: It is also increased by credit and decreased by debit

• Revenue: It is also increased by credit and decreased by debit

A debit is an entry made in the accounting books that either increases an asset or expense account or decreases a liability or equity account. 

On the other hand, credit is an entry made in accounting that either increases a liability or equity account or decreases an asset or expense account.

In each account, there must be a balance between debits and credits. This means that the end result should result in both sides equaling out. Debit entries are usually made on the left-hand side, and credit entries are made on the right-hand side in the books of accounts.

Debits and credits are caused by the following accounting equation on which the entire structure of accounting transactions is built, which is given by:

Assets = Liability + Equity

The Classical Approach to Debit and Credit

There are few theories on the origins of the abbreviations used in bookkeeping for debit (DR) and credit (CR). To help make sense of these ideas, here is a brief introduction to the use of debits and credits.

An increase in the value of resources is a debit to the account, whereas a decrease is a credit. On the other hand, An increase in liabilities or investor's value is represented as a credit (CR), and a decrease is represented as a debit (DR).

Using this two-fold section technique, accountants enter each debit and credit on two sides of an organization's monetary record.

The DR and CR contractions for debit and credit stand for "debit" and "credit" respectively.

Accountants perform debit-credit examinations consistently as part of their obligations. Debits and credits are most useful in a company's accounting or bookkeeping process to balance the books or entries made.

Golden Rules of Accounting

Three standards of debit and credit guide the arrangement of records; they are known as the principles of accounting:

• Real account - Debit what comes in, credit what goes out

• Nominal account - Debit all expenses and losses, credit all earnings and gains

• Personal account - Debit the receiver, credit the giver

If there is anything that governs the world of accounting, it is the rules of debit and credit. Accounting would be a careless wreck without these principles.

To ensure the accuracy of financial records, it is crucial to maintain them in accordance with these standards.

Every business transaction that can be quantified in monetary terms is recorded in a firm's accounting or bookkeeping system. An arrangement of debit and credit has been concocted to record such exchanges, which records such occasions through two unique records.

The entries made on the journal accounts are passed based on the above-mentioned golden rules of accounting, and to apply these rules, one must first be familiar with the kind of account and then apply these rules.

These guidelines govern each process and are universally accepted.These guidelines outline the procedure of main functions in order to bring consistency in the presentation and overall structure of the concept.

Debit vs. credit account

There are some major differences between debit and credit in accounting, and they are as follows:

Debit vs. Credit Transactions

To easily understand, we'll take the example of a debit and a credit card. We all know there's an undeniable difference between debit and credit cards.

A debit card pulls funds directly from your account, while a credit card allows you to borrow money from the card issuer, with the option of paying off the balance in full or making regular installment payments.

In short, debit and credit card transactions are handled differently behind the scenes. A debit card transaction is done by utilizing your PIN (Personal ID number), which is a web-based transaction finished continuously.

When you complete a debit transaction, you authorize the purchase with your PIN, and the transaction is automatically recorded for accuracy.

Debit card transactions do not have repayment deadlines, whereas credit card transactions have repayment deadlines to avoid accumulating interest charges, which could result in outstanding balances.

Credit cards can offer some benefits over debit cards, though they can also have some downsides. Some credit cards might also provide additional warranties or insurance on purchased items that go beyond what the retailer is offering.

Key Differences

There are three fundamental contrasts between credit card and debit card transactions, such as:

1. Cost: Merchants generally get charged per transaction, whether a debit or credit card is utilized. The amount charged depends on whether the card was handled through a credit card or debit card network. Cards handled through a credit card network are charged the standard credit transaction fee. Contingent upon the processor, debit transactions or exchanges are dependent upon a debit card rate.
2. Disputes: A dispute will show up on a merchant's explanation as a debit back, whether it was a debit or credit card transaction.
3. Essentials and Surcharges: Merchants cannot add surcharges to customers using debit cards.

Examples of Debits and Credits in Accounting

Let's understand a few examples:

Example 1

Assume Arihant Corporation sells a product to a customer for $2,000 in cash. This results in revenue of $2,000 and cash of $2,000. 

Arihant must record an increase in cash (asset) in the debit account and an increase in the revenue in the credit account. The entry should look like this:

As shown in the above example, both the debit and credit sides have equal amounts, i.e., $2,000, and are balanced. 

Example 2

Arihant Corporation also buys a machine for $20,000 on credit. This is an addition of machinery (which is a fixed asset); therefore, it should be recorded in the debit account. On the credit side, this is an increase in the accounts payable (liability). The entry should look like this:

The total sum of debits must equal the total sum of credits for each individual transaction to maintain accounting accuracy. However, slight imbalances in individual accounts are admissible if they preserve the accounting equation (Assets = Liabilities + Equity).

Debit Credit Analysis

The following are steps to understand and remember the debits and credit accounting transactions easily:

Step 1: Learning the terms 

The first step is to familiarize yourself with the meaning of debit and credit and try to understand the major difference between them.

Step 2: Use acronyms

The next step is to remember the difference between them by using some acronyms. Use acronyms to remember the difference between debit and credit. This is one of the simplest methods to remember the difference between debit and credit.

The below-mentioned accounts are increased with a debit: Dividends, Expenses, Assets, Losses, and you can remember these all with an acronym called "DEAL."

On the other hand, Gains, Income, Revenues, Liabilities, and Stockholders' Equity accounts are increased with credit; you can use an acronym as "GIRLS."

Step 3: Set up the balance sheet for every transaction

The third step is to set up the balance sheet with all the debit and credit entries in the books of the account. It is an important step as all the entries need to be entered correctly.

Step 4: Set up the ledgers for each account

A general ledger is a standard method of recording the debit and credit entries for a particular accounting transaction, and all the debit and credit entries are entered in each ledger account.

Step 5: Consider what is being exchanged during the transaction

In this step, whenever there is any transaction, there will be an exchange of things, and that needs to be clearly understood.

Step 6: Calculate the ending balance in each account

The last step is to calculate the ending balance in each account and update the balance sheet. Always remember that the balance sheet should be appropriately maintained to stay in balance. i.e., the debit and credit sides equate to the same amount. 

Many new accountants or bookkeepers nowadays enter the profession without a clear understanding of how different types of accounts in accounting relate to each other and how debit and credit affect these accounts.

Debit and credit represent the duality of financial transactions, wherein each transaction affects at least two accounts, with one account receiving a debit entry and the other a credit entry.

Understanding debit and credit will have a great impact not only in the accounting field but also on the growth of the business. This article has provided basic knowledge regarding analyzing debits and credits in accounting.

Researched and authored by Spoorti Biradar | LinkedIn

Free Resources

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