Credit in Accounting
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Table Of Contents
Credit in Accounting Meaning
Credit in accounting refers to that side of the double-entry system where there is a decrease in assets or expenses and an increase in liabilities. In accounting books, Credit (Cr) items are shown on the right-hand side.
In other words, assets moving out of the business, income generated by a business, and outstanding sums are credit items. Credit is also used to denote any amount owed by a debtor to a creditor. In an accounting ledger, the credit balance is the excess, recorded on the right-hand side.
Table of contents
- Credit in accounting refers to the right-hand side of the double-entry bookkeeping where the business records all the outflow of mone. This includes the decrease in assets or expenses and any increase in liabilities, income, or equity.
- In business, it is the due amount to be paid by a debtor to their creditor. In banking, it is an increase or addition of funds to the bank account of an account holder.
- A credit side balance always has an equal corresponding debit side balance—for every bookkeeping entry.
- Also, the term credit is used to represent an individual's or corporation's financial position or credibility. This is also referred to as creditworthiness or in terms of credit scores.
Credit in Accounting Explained
Credit has different meanings in different contexts. It is the right-hand side of the double-entry system of accounting. It documents all the transactions where money flew out of a business.
However, in business, the credit side is only one face of the coin. Its corresponding face is referred to as the debit side. A journal entry is considered valid only when both sides are equal.
According to the rules of accounting, given below are the various conditions where an account is credited:
- Any decrease in material or immaterial assets. This includes cash and cash equivalents, land, manufacturing plants, equipment, furniture, inventory, patents, goodwill, and accounts receivables.
- Any increase in short-term and long-term liabilities. This includes accounts payable, interest payable, bank account overdraft, capital leases, bonds payable, bank loans, deferred tax liabilities, etc.
- Any decrease in business expenses —wages, salary, commission, advertising, marketing, maintenance and repair, rent, interest, tax, insurance expense, etc.
- Any increase in the business revenue. This includes interests received, rent received, commissions, capital gains, royalty income, profit income, etc.
- Any rise in the shareholders' equity—issuance of new stocks or increase in retained earnings.
Against every debit entry, a journal includes an equal credit entry. In a general ledger, the credit balance is represented as a negative balance. In banking, any act of adding money to the bank account is called 'crediting.'
Also, in the financial market, the term credit is used to denote any kind of loan or advance—mortgage loan, car loan, home loan, line of credit, etc.
Examples
Let us now go through various journal entries to understand the application of the concept.
Example #1
The company sells machinery worth $10000 and receives a cheque against it.
| Particulars | Debit ($) | Credit ($) |
| Bank A/c …Dr. To Machinery A/c (Machinery sold) | 10000 | 10000 |
In the above scenario, there is a decrease in machinery (asset); therefore, it is recorded as a credit item.
Example #2
The company took a loan from a bank worth $50000.
| Particulars | Debit ($) | Credit ($) |
| Bank A/c …Dr. To Loan A/c (Borrowed funds from the bank) | 50000 | 50000 |
In the above scenario, there is an increase in loans or borrowings (liability); therefore, it is documented as a credit item.
Example #3
The company adjusted the prepaid rent worth $9000 against due rent for the current period.
| Particulars | Debit ($) | Credit ($) |
| Rent Expense A/c …Dr. To Prepaid Rent A/c (Prepaid rent adjusted) | 9000 | 9000 |
In the above scenario, there is a decrease in rent expenses; therefore, the prepaid rent is recorded as a credit item.
Example #4
The company receives $5000 as interest on investment.
| Particulars | Debit ($) | Credit ($) |
| Bank A/c …Dr. To Interest on Investment A/c (Prepaid rent adjusted) | 5000 | 5000 |
Here, there is an increase in interest (income); therefore, it is written as a credit item.
Example #5
The company issued new stocks to raise share capital of $175000.
| Particulars | Debit ($) | Credit ($) |
| Bank A/c …Dr. To Share Capital A/c (Issuance of new shares) | 175000 | 175000 |
In the above instance, there is an increase in share capital (equity); thus, it is shown as a credit item.
Example #6
The company buys goods on credit; goods worth $1500 from Mr. A and goods worth $2400 from Mr. B.
| Particulars | Debit ($) | Credit ($) |
| Purchases A/c …Dr. To A’s A/c To B’s A/c (Goods purchased on credit) | 3900 | 1500 2400 |
In the above scenario, two credit entries were passed against the debit entry (purchases). The amount of the debit item (purchases A/c) equals the total amount credited in A and B's accounts.
Frequently Asked Questions (FAQs)
Debit and credit are the two sides of an accounting book maintained using the double-entry system. Debit represents either an increase in a company’s expenses or a decline in its revenue. There is either an increase in the company’s assets or a decrease in liabilities. On the other hand, credit is the reduction in expenses and the increase in liabilities.
The debit is the left-hand side of the double-entry system, represented as 'Dr,' and credit is the right-hand side of the double-entry system, shown as 'Cr.' Debit documents all the inflow of money into the business. In contrast, the latter accounts for all the outflow of funds from the firm.
Credit accounts often have a negative balance since it indicates an outflow of funds through:
1. Decrease in assets.
2. Increase in liabilities.
3. Increase in equity.
4. Reduction in income.
5. Increase in expenses.
An increase in cash is debited, and a decrease in cash is credited.
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