DEBIT AND CREDIT SYSTEM



Debits and credits are the basis for the system of double-entry accounting that is accepted as standard accounting practice today. The system had its beginning in the Renaissance, when an Italian mathematican and Franciscan monk, Luca Pacioli (1445?-1514?), described an accounting system whereby every financial transaction would have a debit amount and an equal and offsetting credit amount. One of the basic rules of accounting is that, for each recorded transaction, the debit amount must equal the credit amount.

A corresponding rule is that the sum of all debit balances must equal the sum of all credit balances. When bookkeepers run a trial balance, they are checking to make sure that the debit balances equal the credit balances. If they are not equal, an error has been made and must be found. Thus, the debit and credit system of accounting has a built-in means of checking for accuracy.

Accounts are usually set up as T-accounts, where the stem of the "T" serves to divide left and right sides of the account record. All debits are recorded on the left side, and credits on the right side. While such designations are arbitrary, they are nevertheless universally observed. In accounting, the words debit and credit have no other meaning and, unlike in common usage, have no positive or negative connotations. They are often abbreviated as Dr. and Cr.

Increases in asset accounts, such as cash, marketable securities, accounts receivable, or plant and equipment, are recorded in the debit side of the account. Increases in liability accounts, such as accounts payable or accrued expenses, and in owners' equity accounts, such as paid-in capital or capital stock, are recorded in the credit side of the account. Similar rules apply to revenue and expense accounts. Since an expense is a reduction in owners' equity, increases in expense accounts are recorded on the debit side. Increases in revenue accounts are recorded on the credit side, since revenues increase owners' equity. In this way account balances conform to the equation that states that a company's assets are equal to the sum of its liabilities and its owners' equity.

[ David P. Bianco ]

FURTHER READING:

Davies, Glyn. "Credit: 6,000 Years Old and Still Evolving Vigorously." Business Credit, June 1996, 16.

Guttman, Robert. How Credit-Money Shapes the Economy: The United States in a Global System. M.E. Sharpe, 1994.

Rosenthal, James A., and Juan M. Ocampo. Securitization of Credit: Inside the New Technology of Finance. New York: Wiley, 1988.

Wray, L. Randall. Money and Credit in Capitalist Economies: The Endogenous Money Approach. Edward Elgar, 1990.



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