Question

1. Define debits and credits and explain how they are used in the recording process. Explain how debits and credits are used to increase each of the 5 account classes.

Answer 1

A double accounting system always has two heads called, Debit and Credit. Each transaction is recorded with a debit and a credit.

The meaning of Debit is differ in three accounting rules -

Real Accounts - where - debit what comes in

Nominal Accounts - where - debit all expenses and losses

Personal Accounts - where - debit the receiver

Similarly, the meaning of Credit is also differ in three accounting rules -

Real Accounts - where - credit what goes out

Nominal Accounts - where - credit all incomes and gains

Personal Accounts - where - credit the giver

The meaning of debit and credit will differ in each of these accounts based on the nature of transaction it relates to each account.

The five account classes are -

1) Assets:

Assets will always has debit balance so when assets are purchased, they are debited and credit decreases them so when they are sold, they are credited.

2) Liabilities:

Liabilities will always has credit balance so when they are incurred like assets purchased on account so Accounts Payable which is a current liability incurs so it is credited so credit increases them and debit decreases them when they are paid.

3) Equity:

Equity is the shareholders' cumulative balance amount that was invested in a particular company so equity will increase with a credit as they always has credit balance just like liabilities but the nature of equity is different. For example, when cash is invested into the business to start then equity get credited because it incurs or increases and debit decreases the equity when the equity is sold and settelment is done to respective shareholder or shareholders.

4) Revenue or Income or Gains:

Revenues or income or gains will always has credit balance and any revenue is earned, it is credited because credit increases the revenues or income and debit decrease the revenues due to returns etc. For example, sale revenue is credited when it is earned and when sales are debited with Sales Returns and Allowance account when they are returned by customers.

5) Expenses or losses:

Expenses or losses will always has debit balance so debit increase the balances of expenes or losses and credit decreases the expenses or losses. For example, when salaries are paid, salaries expense is debited and cash which is an asset decreases so it is credited. When loss is incurred on sale of an asset then such loss is debited.