We come across the word debit very often in our day to day lives mainly while dealing with any kind of money transfers or banking activities. Even the ATM card that we use to withdraw cash and make payments is called a debit card. So what exactly does the word debit mean and how is it relevant in the world of banking and accounting? Let’s read a little further to see what exactly debit entails and how it is important not just in the banking sector but also in the business sector.
What is Debit?
A debit is an accounting entry made on the company’s balance sheet that results either in an increase in the assets of the company or a decrease in its liabilities. When it comes to fundamental accounting, the debits are always balanced by the credits that work completely opposite to the debits. The abbreviation used for debit in the balance sheet is usually “dr” which stands for “debtor” in short.
To understand the basic concept of debit, you can consider a situation as an example in which a company has availed a loan from a lender to buy some new business equipment. In this case, the company creates a credit account that depends on the type of credit and the nature of the loan availed while simultaneously recording the debit fixed assets.
How does debit work?
The feature debit is present in all double-entry accounting systems and is placed on the top lines in all standard journal entries. Whereas, the credits are always placed or noted on the lines present on the bottom of the debit entry. If the entries are made using a T account, debits are placed on the left side of the chart while the credits are placed on the right side of the chart to have clear and separate entries of both debits and credits without leading to or causing any kind of confusion.
Both these entries—debits and credits are used in the trial balance and modified trial balance to ensure that these credit and debit entries balance each other out. In other words, it means that the total amount of the debits has to equal the total amount of the credits so that both these entries will tally up, which entails that the company’s finances are balanced.
In case the credit and debit balance does not tally up, it leads to a dangling debit, which is a debit balance with no offset of credit balance. This makes the dangling debit eligible to be written off the balance sheet. It most commonly happens when a company buys goods and services. The dangling debit can occur in the financial accounting and is proof that there may be some deficiencies in the company’s balance sheet, which can affect the company’s finance balance if not managed at the right time.
The double accounting systems work on the concept of the debit balance offsetting the credit balance and hence both these entries are extremely important in these systems to keep the company’s finances on the right track and to maintain an accurate record of all the activities affecting the financial system of the company.
What are Debit Notes?
When a company does business with another company, one of the many important records is a debit note, which is proof that the company has created a valid debit entry in its deal with the other company or business. You can see this happen when a consumer goes to the seller to return a product that they have bought earlier and seek reimbursement for their purchase. This is when the buyer has to issue a debit note which will reflect the transaction.
Apart from this, a business can also issue a debit note as a response to the credit note that they receive from the opposite party. Many other situations in which a debit note can be issued include mistakes in the interest charges, fees, or mistakes in the sales, purchases, and loan invoice. In such cases, a debit note is issued by the company or business in an effort to correct the mistake at hand.
This debit receipt or debit note looks fairly similar to an invoice, with some significant differences between the two. One of the main differences is that an invoice reflects the amount which is to be paid after making a sale which means the transaction is yet to take place, whereas the debit note reflects the adjustments or returns on certain transactions that have already taken place. This is done in an effort to resolve the error that might have occurred in the transaction.
How is a Debit card different from a Credit card?
Now that we have seen what debit entry entails in the business world and how it affects the company’s balances when used together with the credit entry let’s have a look at how debits and credits work in the banking sector and affect your banking activities and account balances.
You must already be pretty familiar with the terms debit card and credit card, and many of you must already use one or both of these cards. But what exactly is the difference between these two when in fact they totally look the same on the exterior? Although these cards look the same, and both have a 16 digit card number, expiry dates, and Personal identification numbers or PIN, they are both very different from each other in nature.
The basic concept on which debit and credit cards work is totally different. By using a debit card, you can withdraw money or make payments using the cash or funds that are already existing in your bank accounts. This however is not the case with credit cards. When you opt to use a credit card you have to borrow a certain amount of money from the company that issues you the card and set a certain limit on the card for withdrawing cash or making a purchase. You as a consumer then have to pay the decided amount in the form of a credit card bill.
So to conclude, debits are an important form of entry when it comes to the financing world, whether it is in the business or the banking sector. Knowing about debits and their impotence will help you a great deal in managing your finances well.