Every legitimate company keeps a balance sheet in its transaction records. It is one of the fundamentals of running a business. This balance sheet contains columns on credit and debit. A company is believed to flourish when the sheet shows a proper balance between the two. Here, give more weightage to the debit portion.
A debit in finance and accounting terms refers to a significant decrease in liabilities or a consecutive increase in a company’s assets. It is a powerful accounting tool, which is generally balanced by credits in finances. These two forces work like Newton’s Third Law of Motion, i.e., ‘every action has an equal and opposite reaction,’
When it comes to bookkeeping, around 33% of small businesses hire bookkeepers. Their general task is to keep a log of all the debits and credit transactions of their company.
There is a continuous interplay between credits and debits in a company when they are either attributed to the assets section of the transactions or the liabilities section; for example, if a company seeks to get a loan for a product purchase, it will debit its fixed assets and create a credit liabilities account on the purchase.
A popular abbreviation for debit is ‘dr,’ which is popular in the accounting world.
For the sake of convenience, this article is divided into the following sections:
- How are Debits Balanced by Credits?
- Working Mechanism of Debit
- Debit Notes: Trustable Debit Records
- Margin Debit
- Contra Accounts
- Debit Cards and Credit Cards
How are Debits Balanced by Credits?
Picking up on the part where we mentioned striking a balance between credits and debits, here is how credit works in an opposite directional reaction to credits.
The father of accounting, Luca Pacioli developed a double-entry accounting method, something companies use in the modern-day. Bookkeeping includes the use of this double-entry method to maintain the company’s balance sheet. Pacioli said that it is incorrigible to end a working day at the office without thoroughly reviewing the credits and debits of that day and entering them into the balance sheet.
We can decipher the double-entry accounting method as “Assets Equals Liabilities Plus Shareholder’s Equity.” Here are some thumb rules to remember this:
- An increase in the value of assets is a debit to the account
- A decrease in the value of assets is considered as a credit to the account
- An increase in the liabilities of the company and shareholder’s equity is considered as credit for the account
- A decrease in the liabilities of the company and shareholder’s equity is considered as a debit for the account
Here’s an example.
A company has a client who has assigned a task that the former has successfully completed. The company raises an invoice for the client to be paid. The company nails this invoice amount as a debit in the account receivables section. At the same time, it credits this in the company revenue system. The company’s bookkeeper takes care of this credit and debit procedure in the balance sheet following the double-entry accounting system.
In this way, every transaction the company loses or gains is maintained in the balance sheet by the bookkeeper.
After understanding the interplay between the two terms, it is essential to look into more terms related to debit.
Working Mechanism of Debit
To understand the concept around debit, absolute clarity on a few terms related to it is essential:
Standard Journal Entry
A standard journal entry is also called the general ledger. Every company follows this method to maintain a balance in their transactions of the day. This means that a general ledger or a standard journal entry is used to keep a record and strike a balance between the credit and debit transactions on the company journal.
You can successfully achieve this by subtracting the total number of credits by the total number of debit.
A simple way to do this is to note down all the credits on one column of the page in the journal, and the other column should contain all the debits. Once you have noted down all the transactions of the day and deciphered whether they get a place in the credit column or the debit, the calculations on both ends should match, and a subtraction of the two columns should amount to zero.
Only then are you rest assured that you have balanced the books.
A T-account is an informal connotation of a double-entry account or a simple ledger account. T-accounts are a diagrammatic representation of what a normal ledger account should look like.
In a T-account, it is more about how the page looks rather than the actual conclusions of the credit and debit accounts.
The horizontal straight line on top of the alphabet is where you place the page’s title. It can be transactional information about anything or even about a particular day in the week.
The vertical portion of the alphabet is the dividing line on either side, of which the columns of debit and credit go.
Hence, the alphabet T shows how a company maintains a general ledger.
A dangling debit is a moment of ledger dilemma where the credits do not offset the debit portion as observed in standard double-accounting entries. A company reaches the stage of dangling debit on account of the purchase of goodwill, which creates an indent in the credit cycle.
When can you understand your balance sheet has arrived at a dangling debit? It is when your credits cannot be written off against the debits. It occurs when the debit side of the column is complete, but the credit side has a missing component. In this way, you cannot write off the balance.
More often than not, the failure to recognize the presence of a dangling debt in a ledger points to inherent discrepancies your company will have to face. This precisely is the first phase of fraudulent activity circulation that must be put to an end before it gains impetus.
When a company experiences a dangling debit, they register it as negative reserves or deductions against the shareholder’s equity in the company.
It is easy to confuse a dangling debit with a debit balance, but we will get to it in a while.
Debit Notes: Trustable Debit Records
Debit notes are records of transactions that are put on the debit side of the column. This proves that B2B transactions with your company are legitimate, and there is no form of fraudulent activities taking place in the transactional records of the company.
A debit note is a form of purchase validation via which the supplier needs to validate the reimbursed amount. This occurs in case a purchaser returns products to the supplier.
Possible errors that can take place in sales, purchases, or any other transaction can be corrected with the correct entry of debit notes through which the company recognizes and validates the transactions.
Debit notes make adjustments in the credit and debit factors of the balance sheet for transactions that have already taken place. For this reason, it is quite distinctive from an invoice.
Before understanding how debit on margin accounts work, you must understand what buying in margin means. Buying in margin is also called debit balance.
This implies a situation when an investor uses some of their money as well as borrows funds from the brokerage, which s/he then combines to purchase shares of a company. Even though the investor could use their own money, s/he used the funds from a brokerage which s/he now owes to the broker. The funds taken from the broker allow the investor to purchase more shares which s/he could not do so earlier with their own money, due to insufficiency.
The brokerage records this as a debit amount on the investor’s account, which represents the cash cost of the transaction to the investor.
In a margin account, the debit balance is the amount the customer owes the brokerage on the purchase of the much-required securities. Post this successful security purchase by the customer, the debit balance must be put into the customer's margin account to reflect the transaction.
Other terms related to margin debit are long margin positions and short margin positions. Long margin positions reflect debit balances, whereas short margin positions are attributed to credit balances. An interesting fact is that a trader’s margin account has both long and short margin positions. This is where the credit margins can offset the debit ones.
The term contra literally means acting in the opposite direction. So, a company usually turns to contra liability accounts to reduce the value of a related account. The sole purpose of its debit is to ensure that the liabilities of the current account are transferred to another.
In this act of adjustment, the book value of an asset or liability is balanced. When companies issue bonds and purchases security, contra liability accounts are used to balance out the liabilities.
It works in opposite reactions to normal accounts. The contra account records a credit when debit is recorded in the normal balance account. There are precisely four (4) types of contra accounts:
- Contra Asset
- Contra Liability
- Contra Revenue
- Contra Equity
The two most popularly used contra accounts are contra assets and contra liabilities. Contra assets include accumulated depreciation and are associated with reducing the balance of an asset since they are recorded with a credit balance.
On the other hand, a contra liability account is recorded with a debit balance, hence ensuring the reduction of liabilities. Usually, the companies that issue bonds deal with contra liability accounts.
In practice, contra assets are far more popular than contra liability. This is because contra assets closely follow the upliftment of a business through a reduction in assets.
Debit Cards and Credit Cards
Although debit and credit cards both let individuals indulge in transactions through cards linked to bank accounts, there is a difference between the two.
Throwing light on some similarities between the two:
- They both look identical
- They both have 16-digit numbers
- They have magnetic strips along with expirations dates
- Both debit and credit cards have EMV chips
So what is the difference? There is one feature under both that starkly distinguishes it from the other.
Debit cards provide a passage for you to spend the money which you have deposited in the bank.
Credit cards let you borrow money from the person who issued the card to withdraw cash or purchase items but only up to a certain limit.
The different types of credit cards include:
- Standard Cards
- Premium Cards
- Reward Cards
- Balance Transfer Cards
- Secured Credit Cards
- Charge Cards
The different types of debit cards include:
- Standard Debit Cards
- Electronic Benefits Transfer( EBT) Cards
- Prepaid Debit Cards
Thus debit is an umbrella topic under which a wide range of related issues resides. Although there are more terms related to debit, the ones mentioned above are used the most in businesses today.
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- A debit in finance and accounting terms refers to a significant decrease in liabilities or a consecutive increase in a company’s assets
- There is a continuous interplay between credits and debits in a company when they are either attributed to the assets section of the transactions or the liabilities section
- A standard journal entry is also called the general ledger. Every company follows this method to maintain a balance in their transactions of the day
- A T-account is an informal connotation of a double-entry account or a simple ledger account
- A dangling debit is a moment of ledger dilemma where the credits do not offset the debit portion as observed in standard double-accounting entries
- Debit notes are records of transactions that are put on the debit side of the column
- In a margin account, the debit balance is the amount the customer owes the brokerage on the purchase of the much-required securities