Debits and credits in accounting constitute the two most essential double entry method of bookkeeping, prevailing since 1400s. For every transaction there has to be a debit and corresponding credit and the two must remain equal. Debits add to assets and reduce liability and equity. Credit does the reverse, increasing liabilities and equity and decreasing assets.
Debits and credits are shown in two different columns in a balance sheet. Debits are on your left and credits appear on right. Accounts that get raised with debit include expenses, dividends, assets and losses whereas accounts which get raised with credit are revenue, income, profits, liabilities and stockholders’ equity. As account on one side of the balance sheet is decreased, there is a corresponding increase on the other side of the balance sheet. For instance, when you purchase a vehicle for business on cash payment, your cash account gets redcued or credited while your expense gets enhanced or debited. That’s how debits and credits in accounting are balanced.
Any financial balance sheet must always have credit entries equaling debit entries to make up for each other. Suppose you borrow money for buying a house. That home is your asset but the borrowed amount is your liability. As you make payments toward that loan or borrowed amount, your possession on home increases while your loan gets reduced. In effect, the payments you make increase the worth of your asset, the house and reduce your liability, the amount of loan.
This way of accounting involving two entries or double entry necessitates a minimum of one debit and one credit for every transaction. Certain entries may be categorized among three, yet debit must always remain equal to credit. Going back to the above example, as you payback loan or mortgage amount, the cash you pay gets credited or reduced but the liability is reduced or debited by the amount of principal part of the payment and amount paid towards interest is debited for the interest payable on borrowed money.
Credits and debits are tools employed for evaluating your financial status. When you purchase any item, your cash gets reduced or credited, while your stock goes up or is debited.
Debits and credits in accounting consisting of double entry have been in place for more than 500 years, though it may confuse at times. This way of bookkeeping enables us to have checks and balances of every account, which makes it convenient to locate errors in bookkeeping and evaluate financial health quickly.