Individuals and businesses must follow accounting procedures and regulations to report expenses, revenues, assets, liabilities, contingencies, etc.
However, when you are just starting to understand accounting and financial reporting, the rules of debit and credit can be very confusing. Yet another confusion that exists is the difference between double-entry, single-entry, GAAP, IFRS, etc.
It might not be such a big issue for firms and businesses as they hire professional accountants to take care of all debits and credits.
Debits and credits can be confusing when you are a common person doing a nice job but are supposed to manage your finances by yourself.
As an accounting student learning the basics, you can easily confuse debit & credit rules changing according to the accounting system, statement, subject, etc.
As a layman, the most commonly asked questions are what is meant by “credited to your account” or “debited from your account”?
And how do we understand the rules once and for all? So we have come up with this article to answer your queries regarding credit or debit to your bank account, income statement, balance sheet, and so on.
So let’s get into it.
What Is Debit?
In most simple terms, debt is a term used to record any money you have taken from your bank account.
This definition is for those people who are not accounting professionals or students and just want to understand it in relation to their bank accounts.
However, the meaning of debit might change when preparing financial statements. It will be different for ledger accounts, income statements, cash books, bank statements, and balance sheets.
We won’t confuse you yet and explain the working of debit with different contexts in the coming sections.
For now, you should know that the world debit has been derived from “debitum,” which means what is due. It is a term of Latin origin. It implies what is due to be received from others.
What Is Credit?
So if a debit is to be used for recording any money you take out from your bank account, the credit will be the money coming into your account.
Right?
Well, the definition of credit for a person who is just dealing with a bank account will work like this. But again, the meanings vary, and things change as you move to a little more advanced level of accounting.
However, we will save the discussion for the next sections.
The term credit has also been derived from a word of Latin origin. Credit stands for “that which is entrusted.” It implies what others entrust us with in the form of loans.
Debit And Credit Rules For Expenses & Revenues
In a double entry system, debit and credit have greater value than in a single entry system. So how will you define debit and credit for the accounting income statement?
Debit and credit are two equal and opposite sides of the same transaction that complete each other. Debit entry is recorded on the left side, whereas credit entry is recorded on the right side.
You are preparing an income statement and must record the expenses and revenues. How are you going to do that? How will debit and credit work for it?
So here are the rules for income statement:
- When you are making expenses, it is taking your money out of the cash/bank account. Therefore, it will be a debit entry made in your income statement. To make an entry, you will debit the expense and credit the cash, bank, or account payable.
- When you are receiving your salary, generating revenues by selling, or receiving income from different sources, it increases the balance of cash in your account. There is a net increase in your assets. Therefore, it will be a credit entry made to your income statement by debiting cash(increase in your assets).
Debit And Credit Rules For Assets & Liabilities
How do debit and credit rules work when you prepare your balance sheet and show an increase or decrease in assets and liabilities?
There is no debit or credit side in a balance sheet. Instead, some items are recorded on the assets side while others are recorded on the liabilities & equity side.
However, debit and credit are related to assets & liabilities, and every transaction taking place impacts assets or liabilities.
Either liabilities are decreased or increased, assets are increased or decreased, and equity is increased or decreased.
So how does it work?
- Whenever there are a transaction increasing assets, it is recorded as a debit balance. Whenever a transaction decreases one or more assets, it is recorded as a credit.
- For liabilities, a transaction resulting in a liability generation or increased liabilities is recorded as a credit. On the other hand, when a transaction results in a decrease in liabilities, it is recorded as debit.
Credit And Debit On Bank Statement
How do credit and debit work when you are considering a bank statement of your account? Does an increase in assets recorded as debit and a decrease in assets as credit? Or do the rules for liabilities remain the same?
Well, let’s see how it works for a bank statement. But before we dive into that, it is important to explain that you are your bank’s customer.
The relationship between the bank and its customer implies that the bank is bound to provide money on demand whenever a client needs it.
You are wrong if you think everything you deposit into your account is kept as cash. The banks are bound to give you the money when you need it, but there is nothing such as keeping cash for every account holder.
This example will help you understand the working of debit and credit for your bank statement.
What Is Meant By Credited To Your Account?
So when you receive your salary on the 1st of the month, your bank sends you an auto-generated message saying, “$xxx.xx has been credited to your account number 1203 xxxx xxxx 121.”
So what does it mean? It is clearly an increase in your assets, but why are you being told about credit?
Well, here comes the explanation of banker and customer relationship. A bank is bound to provide money to its customers out of their deposit whenever they need it. Now, you have added money to your account, which is a virtual thing.
But, it implies that now the bank’s liability has increased, and they have to pay money on demand. The entry made in the bank’s account will be a cash increase to creditor(customer account) increase. Therefore, you receive a message “credited to your account.”
What Is Meant By Debited To My Account?
So when you spend your money to pay your bills, rent, etc. or withdraw money out of your ATM, your bank sends you an auto-generated message saying, “$xxx.xx has been debited from your account number 1203 xxxx xxxx 121.”
So what does it mean? It is clearly a decrease in your assets, but why are you being told about “debited from your account”?
Well, here comes again the explanation of banker and customer relationship. A bank is bound to provide money to its customers out of their deposit whenever they need it.
So whenever you deposit money to your account, it increases the liability of the bank against the increase in cash. When you are taking money out of your account, what entry will your bank make in its statements?
The entry made in the bank’s account will be a cash decrease to creditor(customer account) creditor decrease.
The liability of the bank has decreased by the amount you have withdrawn. Therefore, you receive a message “credited to your account.”
The second perspective to debiting from your account is expense & revenue explanation. Whenever you are generating revenues and depositing them in your bank account, it is a credit to your account and vice versa.
However, it is not a satisfying explanation for justifying bank statement changes.
Debit & Credit: Unending Debate
We have explained how debit and credit work for bank statements, income statements, and assets & liabilities.
We hope you can better understand what it means when you receive a message from your bank saying “credited to your account.” Do let us know if you have more such queries. We will be happy to cover them in future blog posts.