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RULES OF DEBIT AND CREDIT Accounting Equation
Approach [MODERN (AMERICAN) APPROACH]

  • ASSETS

Every business owns and possesses assets. The various assets and their value will differ on the basis of and nature of business. Generally firms own cash in hand, cash at bank, stock of goods, building, plant machinery furniture, vehicles and debtors, etc. The business makes use of these assets for earning income are certain dealings in these assets and the result is either increase in the value of assets or decrease in value. The increase or decrease in the assets must be recorded systematically and scientifically, so that financial position of the business may be assessed.

Business is the representative of the proprietors of the business. Whatever the business spends, the proprietors have to reimburse and repay it back. In other words, proprietors become liable for expenditure on acquiring assets and their capital will be reduced. In this way, increase in assets will be debited because it will proprietor’s equity and debit means decrease in the proprietor’s share in the business. In the same way, in the assets will increase proprietors’ equity and thus credited. The fact can be presented as under:

   Assets
Debit                                                                                              Credit
               Increase ( +)                                                                             Decrease (- )


While recording business transactions, we have to identify whether the transaction relates to assets, liabilities, capital, expenses or losses and revenues or profits. If the transaction relates to assets, we have to that the transaction increases assets or decreases it. If it increases, the increase is debited and if it decreases, the decrease is credited. It can be summarized as under :

Debit increase in the assets  

Credit decrease in the assets

It has been an accepted fact that assets either increase or decrease. The increase in the assets are debited and the decrease in the assets are credited. In case of commencement of the business cash will increase, so cash account will be debited. While purchasing furniture for business use, furniture will increase and thus furniture account will be debited. At the same time as the payment for furniture has been made in cash, therefore, it will decrease cash and thus cash account will be credited. In the same way, if a part of machinery is sold, cash will increase because the payment has been received in cash and thus debited. The balance of machinery will decrease as such machinery account will be credited. In case of depreciation on fixed assets, the balance of assets will reduce and thus credited. While recording, we have to identify assets account in the transaction and then satisfy ourselves whether, there has been an increase in the assets or decrease in it. The assets, whose value has increased will be debited with the amount of increase and the assets decreasing in the value will be debited with the amount of decrease.

  • LIABILITY

The liability of the business, like its assets either increases or decreases. An increase in the liability will increase proprietor’s claim against the business because the amount borrowed has been received on behalf of the proprietor and will definitely increase proprietor’s equity as such, increase in the liability is to be credited and decrease in it will be debited. The fact regarding rules of ‘Debit’ and ‘Credit’ in case of liabilities can also be presented as under :

                                                                                                                                  Liabilities

                                                                          Debit                                                                                                      Credit

                                                                          Decrease (-)                                                                                       Increase ( +)

In case of borrowing Rs. 7,000 from Mhabemo, firm’s liability will increase, therefore Mhabemo’s account will be credited. If the payment is made to Mhabemo, liability of the business towards him will reduce and thus his account will be debited. The rule can be summarized as under:

  Debit decrease in the liability
  Credit increase in the liability

  • CAPITAL

Capital represents proprietor’s account. Amount introdvced by the proprietor as capital will increase his claim against the business and thus capital al:count representing increase in proprietor’s equity will be credited. In the same way, amount withdrawn by the proprietor will reduce capital and thus debited. The rule regarding capital can be presented as under:

                                                                                                                                    Capital
                                                                          Debit                                                                                                              Credit 
                                                                         Decrease (- )                                                                                               Increase ( +)


In case of commencement of the business the proprietor introduces capital. He may also bring additional amount of capital in the business. He may also be allowed interest on capital. His capital balance will increase with the initial investment, additional funds and even with the interest on capital so capital account will be credited in these cases. If there is any loss or drawings made by the proprietor the capital will reduce and thus capital account will be debited. The rule can also be summarized as under:

        Debit decrease in capital
         Credit increase in capital

  • REVENUE AND PROFIT
Proprietor’s equity increases due to increase of revenue, so revenue account is credited with the increase. Decrease in the revenue will decrease proprietors’ claim against business, so revenue account will be debited with the decrease. Receiving interest is a revenue gain. It will increase proprietor’s capital, so interest account will be credited. At the end of accounting period, interest account will be closed by transfer to profit and loss account and thus in this case interest account will be debited. Decrease in the revenue or increase in the expenses are synonymous. In both cases proprietors equity decreases so increase in expenses and decrease in revenue are debited. This rule of debit and credit can also be displayed as under:

Revenue and Profit

                                                           Debit                                                                                                                      Credit

                                                   Decrease (-)                                                                                                                 Increase ( +)


Revenue received and profit earned is the liability of the business. The amount of profit is to be credited to proprietor’s account, because profit is the reward for the risk taken by the proprietor, so profit will be credited. The rule can be summarised as under :

Debit decrease in revenue and profit
Credit increase in revenue and profit

  • EXPENSES AND LOSSES

Expenses and losses reduce proprietors’ claim against business so these accounts are debited when they increase. Reduction in expenses or losses will increase proprietors’ equity, as such it has to be credited. The rule regarding debit and credit concerning expenses and losses can also be presented as under :

                                                                                                                  Expenses and Losses
                                                                Debit                                                                                                                        Credit
                                                               Increase ( +)                                                                                                       Decrease (- )

In case of payment of salaries to employees, salaries, as an expense will increase and thus debited. The salaries amount will be closed by transfer to Profit and Loss Account. The transfer will reduce or close salaries account and thus it will be credited. It can be summarised as under :

Debit increase in expenses and losses
Credit decrease in expenses and losses

All business transactions can be classified as assets, liability, revenue, expense and capital. All the business transactions either increase or decrease them. The increase and decrease is either debited or credited the basis of rules explained for different items. The above rules can be put together as under:

SUMMARY OF RULES OF DEBIT AND CREDIT (MODERN APPROACH)

Debit Credit
Increase in assets                                                                           Decrease in assets
Increase in expense or loss                                                               Decrease in expense or loss
Decrease in liability                                                                       Increase in liability
Decrease in capital                                                                                Increase in capital
Decrease in revenue and profit                                                   Increase in revenue or profit

The above approach towards debit and credit is termed as American approach or modern scientific approach. The rules have been developed after scientific study and analysis. They have been tested and verified in the real situations of accounting and, therefore prove to be true for accounting record of all business transactions. The earlier conventional or traditional approach towards recording business transactions and its rules for debit and credit were different.