Rules of debit and credit
Definition and explanation
The rules of debit and credit (also referred to as golden rules of accounting) are the fundamental principles of
modern double entry accounting that guide accountants and bookkeepers in journalizing financial transactions
and updating ledger accounts of a business entity. Since the accounting cycle starts with a journal comprising of
debit and credit entries, the use of a double entry accounting is not possible without strict adherence to these
rules. The debit and credit rules are the heart of accounting and their understanding is extremely important for
individuals who are responsible for handling the accounting system of a business entity.
It is explained that an event can be journalized as a valid financial transaction only when it explicitly changes the
financial position of an entity. In accounting, a change in financial position essentially signifies an increase or
decrease in the balances of two or more accounts or financial statement items. The rules of debit and credit
determine how a change affected by a financial transaction can be updated in a journal and then applied to
accounts in ledger.
Let’s see in detail what these fundamental rules are and how they work while a business entity maintains and
updates its accounting records under a double entry system.
A ledger account (also known as T-account) consists of two sides – a left hand side and a right hand side. The
left hand side is commonly referred to as debit side and the right hand side is commonly referred to as credit
side. In practice, the term debit is denoted by “Dr” and the term credit is denoted by “Cr”. In the rest of this
discussion, we shall use the terms debit and credit rather than left and right.
When a financial transaction occurs, it affects at least two accounts. For example, purchase of machinery for
cash is a financial transaction that increases machinery and decreases cash because machinery comes in and
cash goes out of the business. The increase in machinery and decrease in cash must be recorded in the
machinery account and the cash account respectively. As stated earlier, every ledger account has a debit side
and a credit side. Now the question is that on which side the increase or decrease in an account is to be recorded.
The answer lies in the learning of normal balances of accounts and the rules of debit and credit.
Normal balance of accounts
The understanding of normal balance of accounts helps understand the rules of debit and credit easily. If the
normal balance of an account is debit, we shall record any increase in that account on the debit side and any
decrease on the credit side. If, on the other hand, the normal balance of an account is credit, we shall record
any increase in that account on the credit side and any decrease on the debit side.
The normal balance of all asset and expense accounts is debit whereas the normal balance of all liabilities, and
equity (or capital) accounts is credit. The normal balance of a contra account (discussed later in this article) is
always opposite to the main account to which the particular contra account relates.
Application of the rules of debit and credit
The basic rules of debit and credit applicable to various classifications of accounts are listed below:
(1). Asset accounts:
Normal balance: Debit
Rule: An increase is recorded on the debit side and a decrease is recorded on the credit side of all asset
accounts.
