Introduction: Q8

Q8: Why do we have ‘debits’ and ‘credits’ in accounting? And what do ‘debits’ and ‘credits’ mean?

A:

For every transaction of a firm there will always be two opposite and equal components: the heads and tails of every transaction, if you like. These two sides or aspects to every transaction are called debits and credits.

The word ‘debit’ comes from the Latin word ‘debere’, which means ‘to owe’. Indeed, the Latin word ‘debitum’ means ‘debt’. The word ‘credit’ comes from the Latin word ‘credere’, which means ‘to believe’ or ‘to entrust’. The practice has developed to put debits on the left-hand side and credits on the right-hand side of a ledger account. For all their capacity today, computers still have no idea about their left or right. For this reason, computers use positive numbers for debits and negative numbers for credits. So, as we include items in our various ledger accounts we do not refer to increasing or decreasing an account. Rather, we refer to ‘debiting’ or ‘crediting’ an account which will each result in either increases or decreases in accounts depending on the type of account being debited or credited.

The underlying duality of transactions due to the proprietorship or entity concept can be seen when we debit an asset account to record an increase in an asset of a firm. We debit an asset account because when a firm receives an asset it owes an obligation to its equity owners to manage that asset well and provide a return on it for their benefit. This is a firm’s obligation to its owners. It is what it ‘owes’ its equity owners. There is the sense that a firm is obligated to its owners for its assets which it must have gained from them. Also, when we increase either an equity or liability account we credit that account. We do this because equity investors (or in the case of liabilities, debt investors) have entrusted a firm with something of value to them. They have only done this because they believe in the firm.

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