Friday, February 18, 2011

Rules of Debits and Credits


Fundamental notions the accounting structure is built upon are the rules of debits and credits which form part of preliminary studies of accountancy learners. Debits and credits are the ceremonial book keeping and accounting expressions used and followed extensively in accountancy literature as well as in practice. Primarily the accounts are classified into four components and each transaction is attributed as category of any one of them. Such elements are namely:
·         Assets ( further divided into fixed, current, and financial assets)
·         Liabilities ( subdivided  into equity, long term debts, and current liabilities)
·         Expenses ( mainly classified into cost of goods or service and operational expenditures)
·         Revenues ( sale of goods and services and other incomes)
The categories enlisted above are usually joined up as main accounts in the chart of account and are not used in debit and credit entry by themselves. What goes into debit or credit are usually the 3rd or 4th level account heads specified as sub-category of the assets, liabilities, expanses, and revenues. These sub-categories may be labeled or titled differently by every organization but are classified as type of main accounts according to the nature of each transaction almost unanimously every where.
The canons of debits and credits
Rule No. One
Debit               increase in assets
Credit             decrease in assets
Illustration
Equipment bought for $500:
Debit               Equipment                             $500
Credit             Bank                                                   $500
Machinery sold for $ 250:
Debit               Bank                                        $250
Credit             Machinery                                             $250

Rule No. Two
Debit               decrease in liability
Credit             increase in liability
Illustration
Bought material on credit for $1000:
Debit               Purchase Material                $1000
Credit             Accounts Payable                                        $1000
Merchant paid of by $ 500:
Debit               Accounts Payable                  $500
Credit             Bank                                                                 $500
Rule No. Three
Debit               increase in expense
Credit             decrease in expense
Illustration
Paid salaries for $200:
Debit               Salary and wages expense                        $200
Credit             Bank                                                                           $200
Salaries wrongly paid over by $ 20:
Debit               Receivable from staff                                   $20
Credit             Salary and wages expense                                    $20
Rule No. Four
Debit               decrease in revenue
Credit             increase in revenue

Illustration
Revenue earned for $1000:
Bank                                       $1000
Revenue                                            $1000
Supplies below standard valuing $50 returned back by the client and amount paid back:
Revenue                                               $50
Bank                                                                  $50

Another way of expressing rules of debit and credit
The same rules of debit and credit may be expressed differently through classification of the elements of accounts into three types of accounts which are:
1.    Nominal accounts which deal with revenues and expenses
Expenses are debited and incomes are credited
2.    Real accounts which deal with assets
Purchase of assets is debited and sale of assets is credited
3.    Personal accounts which deal with the parties
           Receiver is debited and giver is credited

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