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Rules of Debit and Credit

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Financial Statement Analysis-FIN621
VU
Lesson-3
ACCOUNTING CYCLE/PROCESS
(Continued)
*Rules of Debit and Credit
From our discussion up to this point, we have established following rules for Debit and Credit:
Any account that obtains a benefit is Debit.
OR
Anything that will provide benefit to the business is Debit.
Both these statements may look different but in fact if we consider that whenever an account benefits as
a result of a transaction, it will have to return that benefit to the business then both the statements will
look like different sides of the same picture.
For credit,
Any account that provides a benefit is Credit.
OR
Anything to which the business has a responsibility to return a benefit in future is Credit.
As explained in the case of Debit, whenever an account provides benefit to the business the business
will have a responsibility to return that benefit at some time in future and so it is Credit.
*Rules of Debit and Credit for Assets
Similarly we have established that whenever a business transfers a value / benefit to an account and as a
result creates some thing that will provide future benefit; the `thing' is termed as Asset. By combining
both these rules we can devise following rules of Debit and Credit for Assets:
o  When an asset is created or purchased, value / benefit is transferred to that account, so it
is Debited
I.
Increase in Asset is Debit
Reversing the above situation if the asset is sold, which is termed as disposing off, for
o
say cash, the asset account provides benefit to the cash account. Therefore, the asset
account is Credited
II. Decrease in Asset is Credit
*Rules of Debit and Credit for Liabilities
Anything that transfers value to the business, and in turn creates a responsibility on part of the business
to return a benefit, is a Liability. Therefore, liabilities are the exact opposite of the assets.
When a liability is created the benefit is provided to business by that account so it is
o
Credited
III. Increase in Liability is Credit
When the business returns the benefit or repays the liability, the liability account
o
benefits from the business. So it is Debited
10
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Financial Statement Analysis-FIN621
VU
IV. Decrease in Liability is Debit
*Rules of Debit and Credit for Expenses
Just like assets, we have to pay for expenses. From assets, we draw benefit for a long time whereas the
benefit from expenses is for a short run. Therefore, Expenditure is just like Asset but for a short run.
Using our rule for Debit and Credit, when we pay cash for any expense that expense account benefits
from cash, therefore, it is debited.
Now we can lay down our rule for Expenditure:
o
V. Increase in Expenditure is Debit
Reversing the above situation, if we return any item that we had purchased, we will
o
receive cash in return. Cash account will receive benefit from that Expenditure account.
Therefore, Expenditure account will be credited
VI. Decrease in Expenditure is Credit
*Rules of Debit and Credit for Income
Income accounts are exactly opposite to expense accounts just as liabilities are opposite to that of assets.
Therefore, using the same principle we can draw our rules of Debit and Credit for Income
VII.
Increase in Income is Credit
VIII.
Decrease in Income is Debit
Khizr introduced a capital of Rs.180,000 in his business
Date
Explanation
Ref
Dr.
Cr.
2006
1-Jul
Cash Account
1
180,000
Khizr, Capital
1
180,000
Purchased land for cash for Rs.141,000
Date
Explanation
Ref
Dr.
Cr.
3-Jul
Land Account
141,000
Cash Account
141,000
Purchased Land for
Rs.
141,000
Purchase of building partly on cash (Rs.15,000) and partly
on credit (Rs.21,000)
Date
Explanation
Ref
Dr.
Cr.
5-Jul
Building Account
36,000
11
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Financial Statement Analysis-FIN621
VU
Cash Account
15,000
Accounts Payables
21,000
Sale of part of land on credit for Rs.11,000
Date
Explanation
Ref
Dr.
Cr.
10-Jul
Accounts receivables
11,000
11,000
Land Account
Sold a portion of land
for Rs. 11,000.
Purchase of Office Equipment for Rs.5400 on credit
Date
Explanation
Ref
Dr.
Cr.
14-Jul
Office equipment
5,400
Accounts Payables
5,400
Purchased Equipment
on credit
Partial collection of Accounts Rs.1500
Date
Explanation
Ref
Dr.
Cr.
20-Jul
Cash account
1,500
Accounts receivables
1,500
Collection of accounts
receivables
Payment of liability (A/C Payable) Rs.3, 000.
Date
Explanation
Ref
Dr.
Cr.
31-Jul
Accounts payables
3,000
Cash account
3,000
Payment of liability
Khizr Limited
General Journal
For the month of July 2006
Date
Description
L/F
Dr.
Cr.
1-Jul
Cash Account
180,000
Khizr, Capital
180,000
Capital Invested by owner
3-Jul
Land Account
141,000
Cash Account
141,000
Purchased Land for Rs. 141,000
5-Jul
Building Account
36,000
Cash Account
15,000
12
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Financial Statement Analysis-FIN621
VU
Accounts Payables
21,000
Purchased Building partly for cash and partly on
credit
10-Jul
Accounts receivables
11,000
Land Account
11,000
Sold a portion of land for Rs. 11,000.
14-Jul
Office equipment
5,400
Accounts Payables
5,400
Purchased Equipment on credit
20-Jul
Cash account
1,500
Accounts receivables
1,500
Collection of accounts receivables
31-Jul
Accounts payables
3,000
Cash account
3,000
Payment of liability
13
Table of Contents:
  1. ACCOUNTING & ACCOUNTING PRINCIPLES
  2. Dual Aspect of Transactions
  3. Rules of Debit and Credit
  4. Steps in Accounting Cycle
  5. Preparing Balance Sheet from Trial Balance
  6. Business transactions
  7. Adjusting Entry to record Expenses on Fixed Assets
  8. Preparing Financial Statements
  9. Closing entries in Accounting Cycle
  10. Income Statement
  11. Balance Sheet
  12. Cash Flow Statement
  13. Preparing Cash Flows
  14. Additional Information (AI)
  15. Cash flow from Operating Activities
  16. Operating Activities’ portion of cash flow statement
  17. Cash flow from financing Activities
  18. Notes to Financial Statements
  19. Charging Costs of Inventory to Income Statement
  20. First-in-First - out (FIFO), Last-in-First-Out (LIFO)
  21. Depreciation Accounting Policies
  22. Accelerated-Depreciation method
  23. Auditor’s Report, Opinion, Certificate
  24. Management Discussion & Analyses (MD&A)
  25. TYPES OF BUSINESS ORGANIZATIONS
  26. Incorporation of business
  27. Authorized Share Capital, Issued Share Capital
  28. Book Values of equity, share
  29. SUMMARY
  30. SUMMARY
  31. Analysis of income statement and balance sheet:
  32. COMMON –SIZE AND INDEX ANALYSIS
  33. ANALYSIS BY RATIOS
  34. ACTIVITY RATIOS
  35. Liquidity of Receivables
  36. LEVERAGE, DEBT RATIOS
  37. PROFITABILITY RATIOS
  38. Analysis by Preferred Stockholders
  39. Efficiency of operating cycle, process
  40. STOCKHOLDERS’ EQUITY SECTION OF THE BALANCE SHEET 1
  41. STOCKHOLDERS’ EQUITY SECTION OF THE BALANCE SHEET 2
  42. BALANCE SHEET AND INCOME STATEMENT RATIOS
  43. Financial Consultation Case Study
  44. ANALYSIS OF BALANCE SHEET & INCOME STATEMENT
  45. SUMMARY OF FINDGINS