Difference Between Debit Balance and Credit Balance

Accounting records company transactions using a method known as "double entry." Two entries must be made in a company's accounting books to use the double entry recording system: one must be a debit entry, and the other must be a credit entry. After the accounting records are balanced, there will be a debit or credit entry in each account.

What is A Debit Balance

The term "T accounts" refers to a group of accounts in the general ledger that each reflect a different type of income, expenditure, asset, liability, capital, dividend, etc. The company will follow accounting rules to make debit and credit entries and record business transactions in the T accounts in its ledgers.

A T account's debit entries are always noted on the left side. A balance that is greater on the left side of an account indicates a debit balance when the account's credit and debit entries are balanced.

In accordance with double-entry concepts and accounting standards, many items, including losses, expenses, and assets, are expected to have a debit balance towards the conclusion of the reporting period.

Transactions will be made to the credit (right side) of the T account when these values decline and to the debit (left side) when the asset, expenses, or loss increase in value. Nonetheless, there will always be a debit balance for losses, expenses, and assets.

Examples of Debit Accounts

1. Fixed Assets Accounts: When a fixed asset is bought, it's recorded as a debit transaction. Later, credit entries for depreciation are made, leaving a net debit balance in the fixed asset account.
2. Expense Accounts: Accounts for expenses and losses, such as rent, salary, repairs and maintenance, interest expense, and electricity, always have a debit balance.
3. Investments: Like fixed assets, when an investment is purchased, it's recorded as a debit entry. The investment account will show a debit balance.

What is a Credit Balance

For a transaction to be considered fully documented, a credit entry must be made in addition to the debt entry. Credit balances are commonly noted on the right side, and the credit entry is also recorded in the T accounts.

If the account shows a higher amount on its right side after balancing its debit and credit entries, it's classified as having a credit balance.

Like debit balances, certain items consistently maintain a credit balance after accounts have been reconciled. These items consist of owner equity, income, and liabilities.

As credit balances follow the same principle, entries indicating increases in liabilities, income, or owner's equity are recorded on the right side of the account, while entries indicating decreases in these categories are recorded on the left side.

Credit Balance Accounts

1. Liability Accounts

These accounts show the amounts a company owes. On the balance sheet, debiting these accounts reduces the liability, while crediting them increases it. There are two main types of liabilities: current and non-current. Examples include bank overdrafts, short-term loans, debentures, secured loans, call and put options, deferred tax liabilities, unsecured loans, and financial swaps.

2. Reserves

Reserves are a portion of the profit set aside for specific purposes, such as paying shareholders in case of liquidation or for business growth. There are two types of reserves: revenue reserves and capital reserves. Examples include reserves for dividend equalization, expansion, increased replacement costs, and share premiums.

3. Capital Account

The capital account records the company's funding and income, including minority interest accounts. It tracks retained earnings from one accounting period to the next. The capital account has two main sections on the balance sheet: capital transfers and the acquisition and disposal of non-produced, non-financial assets. Examples include partnerships, LLCs, sole proprietorships, and shareholders.

4. Provisions

Provisions are funds set aside by the company to cover expected future losses or expenses. This helps in calculating the company's gross taxable income. Examples include asset impairments, accruals, depreciation, bad debts, guarantees, and provisions for income tax.

5. Income

Income accounts include revenue and gains from both operating and non-operating activities. Examples include asset sales, declared dividends, consulting services, and interest income.

How Debits and Credits Impact the Balance Sheet

Debits and credits have a significant impact on a balance sheet, which displays a company's financial situation at a certain moment in time.

Let's look at how debit and credit entries affect the various balance sheet categories:

Assets: An organization's assets are its possessions. The value of an asset account rises when a debit is made and falls when a credit is made. For example, when a business purchases machinery with cash, the machinery account is debited, and the cash account is credited.

Liabilities: Liabilities are the obligations and debts that the business owes. A liability account's value rises when there is a credit and falls when there is a debit. For example, when a business pays back a portion of a loan, the loan account is debited, and the cash account is credited.

Equity: Equity is the shareholders' ownership stake in the business. A debit to an equity account indicates a decrease, whereas a credit indicates an increase. When a business declares dividends, for example, the dividends payable account is credited, and its retained income (equity account) is debited.

Difference Between Debit Balance and Credit Balance

Conclusion

For a transaction to be fully recorded under the double entry system, an identical amount must be entered for both the debit and credit entries. The company will document business transactions in T accounts within its ledgers, adhering to accounting recording principles by making corresponding debit and credit entries.

After achieving equilibrium, an account is considered to have a debit balance if it shows a balance on its left side, and it is classified as having a credit balance if it shows a balance on its right side.