Chapter-4

Debits, Credits, and the Trial Balance

A Simple Mnemonic

To understand debits and credits, we need to focus on a mnemonic, AWELOR. The

first three letters, AWE, refer to assets, withdrawals, and expenses respectively.
‘Withdrawals’ refer to funds taken out of the business by the owners. The last three
letters LOR, refer to liabilities, owner’s equity, and revenue respectively. It must be
clarified that the term ‘liabilities’ refers to what the business owes to stakeholders
other than the shareholders.

 To start with, you must understand that assets increase with debits and
decrease with credits. On the contrary, liabilities increase with credits and
decrease with debits.
 Now let us analyse the remaining letters of the mnemonic. If there is a
withdrawal of funds from the business by the shareholders, the business owes
less to the shareholders. Thus withdrawals increase with debits and decrease
with credits.
 For a given revenue or income, the higher the expenses the lower the profits,
and consequently the less is the amount that is owed to the shareholders.
Consequently expenses increase with debits, and decrease with credits.
 Non-shareholder related liabilities, and owners’ equity are both liabilities and
consequently increase with credits and decrease with debits.
 For a given expense figure, the higher the revenue or income, the higher is
the profit, and consequently the greater is the amount that is owed to the
shareholders. Consequently revenues increase with credits, and decrease
with debits.

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 The table below summarizes the impact of debits and credits on various
heads of account, viz., Assets, Liabilities, Drawings, Revenue and Expenses.

The Double Entry System

Every transaction must impact at least two, if not more accounts. For every debit
there must be a corresponding credit. If we ensure that every individual transaction
balances, that is the total debits are equal to the total credits, then the balance sheet,
as the name suggests, will balance.

Here are some examples.

1) A company acquires a computer by taking a short-term loan for Rs. 100,000.

A computer is an asset, and hence the fixed assets account will be debited
with Rs. 100,000. The short-term loan is a liability, and hence, on the liabilities
side, the bank overdraft account will be credited with Rs. 100,000. Thus, in
this case, an increase in an asset is accompanied by a corresponding
increase in a liability.

2) A company uses Rs. 500,000 from its bank account to pay its outstanding tax
liability.

The bank account will be credited with Rs. 500,000 since it is an asset which,
is declining. On the liabilities side, outstanding taxes, which is a current
liability will decline by Rs. 500,000, and consequently will be debited with this
amount. In this illustration, a decrease in an asset has been accompanied by
a decrease in a liability.

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 3) Shareholders invest an additional Rs. 500,000 in the company.

The bank account balance which is an asset, will increase by Rs. 500,000.
Consequently it will be debited. Shareholders’ equity which, is a liability, will
increase by Rs. 500,000, and consequently will be credited. Thus, an increase
in an asset has led to an increase in a liability.

4) A company uses Rs. 250,000 from its bank to acquire a color copier.

The bank account will be credited with Rs. 250,000, since an asset (bank
balance) is declining. Fixed assets will increase by Rs. 250,000, and hence
this account will be debited. In this illustration an increase in one asset has
been balanced by a decline in another asset.

Examples of Debits and Credits

1) A company makes an advance rental payment of Rs. 100,000.

Pre-paid expenses, which is an asset, will be debited with Rs. 100,000.
Bank, which is also an asset, will be credited with Rs. 100,000.
The rationale is that assets increase with debits and decrease with credits.

2) A company buys machinery worth 1 million US dollars.

The machinery account, which represents an asset, will be debited.
The bank account will be credited.
Once again the rationale is that assets increase with debits and decrease
with credits.

3) Company XYZ pays 250,000 US dollars to company ABC by cheque.

ABC’s account will be debited with $ 250,000.
The bank account will be credited with $ 250,000.
There are two possibilities. ABC may have provided goods or services
earlier to XYZ on credit. If so the account would have a credit balance,
because it is a liability. Consequently, once the payment is made, the

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 account will be debited, since liabilities decrease with debits. As usual, the
bank account, which is an asset will be credited.

The second possibility is that XYZ may be making an advance payment to

ABC. If so, the advances paid account, which is an asset, will be debited,
and as before, the bank account will be credited.

4) ABC Ltd., a creditor, was paid Rs. 100,000.

ABC Ltd. will be debited with Rs. 100,000.
Bank will be credited with Rs. 100,000.
The rationale is that money owed to creditors is a liability, which will
decrease with a debit. Cash, being an asset, will decrease with a credit.

5) 25,000 in cash was withdrawn from the bank.

The cash account will be debited with Rs. 25,000.
The bank account will be credited with Rs. 25,000.
The rationale is that one asset has increased, while another has
decreased.

6) Stationery Items worth Rs. 5,000 was purchased in cash.

Debit Printing & Stationery with Rs. 5,000.
Credit the cash account with Rs. 5,000.
The rationale is that printing and stationery represents an expense, and
expenses increase with debits. As before, cash, which is an asset, will
decrease with a credit.

7) Ravi started a business with a capital of Rs. 100,000, which was deposited
in a bank account.
The bank account will be debited with Rs. 100,000.
The share capital account will be credited with Rs. 100,000.
The rationale is that the owner’s equity is a liability for the business, which
will increase with a credit. The bank account is an asset for the business,
which will increase with a debit.

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 8) A business bought furniture by paying Rs. 7,000 in cash.
The furniture account, which represents an asset, will be debited.
The cash account will be credited.
The rationale is that one asset has increased, while another has declined.

9) A business bought raw materials worth Rs. 25,000 from ABC Co. on
credit.
The purchases account, which is an expense, will be debited.
ABC Co. is a creditor, from the standpoint of the business, and hence its
account will be credited.
The rationale is that expenses increase with debits, whereas liabilities
increase with credits.

10) A business paid rent of Rs. 150,000 by cheque.

Rent is an expense, and hence, the rent account will be debited with Rs.
150,000.
The bank account, which is an asset will be credited with Rs. 150,000.

11) A business paid salary of Rs. 50,000 to an employee by cheque.

Salary is an expense and consequently the salary account will be debited
with Rs. 50,000.
The bank account, which is an asset, will be credited with Rs. 50,000.

12) A business receives a commission of Rs. 25,000 by cheque.

Commission received is income or revenue. Thus the commission account
will credited with Rs. 25,000.
The bank account will be debited with Rs. 25,000.
The rationale is that income received should be credited whereas an
increase in an asset will manifest itself as a debit.

13) A company pays 3 months advance rent of Rs. 45,000.

Prepaid rent is an asset, and will therefore be debited with Rs. 45,000.
Cash will be credited with Rs. with 45,000.

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 14) A company purchases a machine worth Rs. 125,000 on credit from Alpha
Ltd.
Plant and Machinery, which represents an asset, will be debited with Rs.
125,000
Alpha Ltd. is a creditor for the business, and hence its account will be
credited.

15) A machine worth Rs. 325,000 has been bought by a company, from Ind-
Tech Ltd. Rs. 200,000 has been paid by cheque, and the balance is yet to
be paid.

Plant & Machinery, which is an asset, will first be debited with Rs. 325,000.

Ind-Tech Ltd.’s account will be credited with Rs. 325,000.

Then Ind-Tech Ltd.’s account will be debited with Rs. 200,000.

And the bank account will be credited with Rs. 200,000.

Then net effect of the transaction will be: Plant & Machinery debited with
Rs. 325,000 (cost of the asset), Bank account credited with Rs. 200,000
(reduction in bank balance) and Ind-Tech Ltd. Account credited with Rs.
125,000 (representing the balance amount due to them).

16) A business owes Rs. 125,000 to Rakesh, and makes a part payment of
Rs. 100,000 by cheque.
Debit Rakesh with Rs. 100,000.
Credit bank account with Rs. 100,000.
The rationale is that Rakesh is a creditor and prior to the payment, his
account would have had a credit balance of Rs. 125,000. When the
payment is made, this account will be debited with Rs. 100,000. Bank, will
obviously be credited.

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 17) Services worth Rs. 25,000 were rendered by a business to Joseph, with
payment yet to be received.
Sales, which represents income or revenue, will be credited with Rs.
25,000.
Since Joseph is a debtor to the business, his account will be debited with
Rs. 25,000.

18) A business has received an electricity bill for Rs. 7,500 but has not paid it.
Electricity charges, which is an expense, will be debited with Rs. 7,500.
Electricity charges payable will be credited with Rs. 7,500, since it is a
liability for the business.

19) The proprietor of a business withdraws Rs. 25,000 in cash.

Capital account will be debited with Rs. 25,000.
Cash will be credited with Rs. 25,000.
The rationale is that withdrawals increase with debits, whereas assets
decrease with credits.

20) A company bought raw materials worth Rs. 30,000 from Prem Prakash on
credit.
Purchases will be debited with Rs. 30,000.
Prem Prakash will be credited with Rs. 30,000.
The rationale is that an expense has been incurred and in the process a
creditor to the business has been created.

21) The company subsequently paid Rs. 27,500 in cash to Prem Prakash as
full and final settlement.
Prem Prakash will be debited with Rs. 30,000 since there is no further
liability.

Cash will be credited with Rs. 27,500. This is an asset which has been
used.

Discount Received will be credited with Rs. 2,500.

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 Discount received is a form of income, and income increases with credits.

22) A company sold goods worth Rs. 7,500 to Niharika on credit.

Sales will be credited with Rs. 7,500.
Niharika will be debited with Rs. 7,500.
The rationale is that revenue has been earned and a debtor has been
created in the process.

23) Subsequently, Niharika paid Rs. 7,000 by cheque as full and final
settlement.
Niharika’s account will be credited with Rs. 7,500 since she has no further
liability.
Bank account will be debited with Rs. 7,000
Bad debts will be debited with Rs. 500.
Bad debts represent a loss of revenue, and hence increase with debits.

24) A company sold goods to Kavita for Rs. 30,000 on credit. A trade discount
of 10% was allowed at the time of sale.
Sales will be credited with Rs. 27,000.
Kavita will be debited with Rs. 27,000.
Unlike discounts which are extended/availed at the time of
receipts/payments, trade discounts at the time of sale are dealt with
differently. The amount paid after discount is reflected as the sale value
and the corresponding amount will be shown as the outstanding amount
for the customer.

25) ABC Solutions Limited is appointed as Marketing Consultant with a

retainer-ship of Rs. 200,000 per month on 16th April. At the end of the
month on Apr 30th, the due amount for the month was paid.

The amount to be paid is Rs. 100,000, for they have provided services for
only half the month. The income tax laws of the country require taxes to be
deducted at the time of payment of professional fees at a rate of 10%.

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 Therefore, only Rs. 90,000 need to be paid to ABC Solutions Ltd. The
balance amount of Rs. 10,000 will be a liability for the business which
needs to be remitted to the Government within the 7th of the following
month.

Thus Consultants and Retainers remuneration will be debited with Rs.

100,000.
Bank will be credited with Rs. 90,000, and
Income Taxes Deducted Payable will be credited with Rs. 10,000.
The remuneration paid to the consultant is an expense, and hence the
debit. Since the payment is being made from the bank, the bank is
credited. The tax deducted, represents a payable, and the account is
credited.

26) Taxes deducted at source as in (25) above were remitted to the

Government on May 4th.

Income Taxes Deducted Payable will be debited with Rs. 10,000.

Bank will be credited with Rs. 10,000.
A liability has been paid, and in the process an asset has been used.

The Trial Balance

The trial balance, is a list of all the debit balances on one side, and a list of all
the credit balances on the other side. Because of the double-entry system of
bookkeeping, for every debit there must be a credit. Consequently, we would
expect the trial balance to balance. However, it may balance despite errors.
The first is an error of omission. An entry has not been recorded. If so, both
the debit and the corresponding credit will be missing, and the trial balance
will not be affected. The second possibility is that, over or under debits are
compensated with over or under credits. For instance a business sells goods
worth Rs. 37,500. However the accountant, by mistake, credits sales with Rs.
27,500 and debits cash with the same amount. The trial balance will obviously
still balance. The third possibility is that the wrong account may be credited or

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 debited. The wages outstanding for a company was Rs. 900,000 and this
account, representing a current liability, ought to have been debited when the
amount was paid. However, by mistake, the accountant debited taxes
outstanding by the same amount. The trial balance will not be impacted. Yet
another possibility is that, an asset is treated as an expense or a liability as
income. Both assets and expenses increase with debits and decline with
credits, and revenue as well as liabilities, increase with credits and decline
with debits. Consequently, there will be no impact from the perspective of the
trial balance. For instance the outstanding wages for a company was Rs.
500,000. The accountant however, credited sales with the same amount.
Finally, the accountant may post the entry to the wrong account. For instance,
Ravi may owe Rs. 25,000 to the business on account of a credit sale.
However the accountant debited Rajeev’s account with Rs. 25,000. There will
obviously be no impact on the trial balance. Finally, where accounts are
maintained manually, there can be compensating totalling errors.

Debits, and Credits Exercise-01

Consider the following Trial Balance as on 31 March, 20XX

Amount
Account
(Rs.)
Share Capital 1,200,000
Retained Earnings 1,200,000
Sundry Creditors 1,000,000
Plant & Machinery ,1200,000
Accumulated
600,000
Depreciation
Furniture & Fixtures 200,000
Prepaid Rent 150,000
Raw Materials Inventory 340,000
Finished Goods
530,000
Inventory
Sundry Debtors 550,000
Cash and Cash
1,500,000
Equivalent
Stationery Expenses 25,000
Outstanding Salaries 100,000
Outstanding Wages 100,000

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Outstanding Taxes 295,000

Transactions in April-June of 20XX

1) Raw materials worth Rs. 250,000 was bought on credit from Cama and
Company.
2) Rs. 240,000 were paid to Rashid Ali, a creditor by cheque.
3) Receivables worth Rs. 150,000 were collected. The payment was received by
cheque.
4) Finished goods costing Rs. 200,000 were sold on credit for Rs. 275,000.
5) Wages of Rs. 100,000 payable for the period, were paid in cash.
6) Salaries of Rs. 250,000 was unpaid at the end of June.
7) Rent of Rs. 30,000 for the quarter, was adjusted against pre-paid rent.
8) An advance payment of Rs. 150,000 was received from Ravi Dayal by
cheque, for goods to be supplied.
9) A dividend of Rs. 120,000 was declared and paid by cheque.
10) The company bought back 10,000 shares with a face value of Rs. 10 each, at
a price of Rs 25 each (please ignore Company Law requirements).
11) Shareholders invested Rs 100,000 in the business for 10,000 shares with a
face value Rs. 10 each (please ignore Company Law requirements). The
payments were made by cheque.
12) Purchased Stationery worth Rs. 5,000 in cash.
13) Bought a machine worth Rs. 130,000 from VST Ltd on credit.
14) Purchased raw materials worth Rs. 125,000 from ABC Ltd on credit.
15) Goods worth Rs. 75,000 were sold for cash.
16) Goods worth Rs. 50,000 were sold on credit to GST Ltd.
17) Salaries of Rs. 30,000 in total were paid in cash.
18) Bought a computer for Rs. 25,000 and paid by cheque.
19) Bought furniture worth Rs. 40,000 from MSS Enterprises on credit.
20) Sold goods worth Rs. 15,000 to Jayesh Patel on credit.
21) Received a cheque from Jayesh Patel for Rs. 15,000.
22) Paid Rs. 40,000 to MSS Enterprises by cheque.
23) Paid salaries of Rs. 125,000 in cash.
24) Interest of Rs. 30,000 is due but has not been paid.

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 25) Bought goods worth Rs. 25,000 on credit, from James Joseph.
26) Paid a commission of Rs. 5,000 to a party by cheque.
27) Deposited Rs. 40,000 cash in the bank.
28) Interest of Rs. 7,500 was received from the bank.
29) Furniture worth Rs. 50,000 was purchased from Mukesh Enterprises on credit.
30) Purchased raw materials worth Rs. 115,000 by cheque.

Identify the account to be debited and the account to be credited, for each
transaction.

Solution

1) Debit Purchases with Rs. 150,000.

Credit Cama and Company with Rs. 150,000.
2) Debit Rashid Ali with Rs. 240,000.
Credit Bank Account with Rs. 240,000.
3) Debit Bank Account with Rs. 150,000.
Credit Receivables with Rs. 150,000.
4) Debit Receivables with Rs. 275,000.
Credit Sales with Rs. 275,000.
5) Debit Wages with Rs. 100,000.
Credit Cash with Rs. 100,000.
6) Debit Salaries with Rs. 250,000.
Credit Salaries Outstanding with Rs. 250,000.
7) Debit Rent with Rs. 30,000.
Credit Pre-Paid Rent with Rs. 30,000.
8) Debit Bank Account with Rs. 150,000.
Credit Ravi Dayal with Rs. 150,000.
9) Debit Dividend Expense with Rs. 120,000.
Credit Bank Account with Rs. 120,000.
10) Debit Share Capital with Rs. 100,000 (face value of shares bought back).
Debit Reserves & Surplus with Rs. 150,000.
Credit Bank Account with Rs. 250,000.
11) Debit Bank Account with Rs. 100,000.
Credit Share Capital with Rs. 100,000.

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 12) Debit Stationery with Rs. 5,000.
Credit cash with Rs. 5,000.
13) Debit Plant and Machinery with Rs. 130,000.
Credit VST Ltd with Rs. 130,000.
14) Debit Purchases with Rs. 125,000.
Credit ABC Ltd. with Rs. 125,000.
15) Debit Cash with Rs. 75,000.
Credit Sales with Rs. 75,000.
16) Debit GST with Rs. 50,000.
Credit Sales with Rs. 50,000.
17) Debit Salaries with Rs. 30,000.
Credit Cash with Rs. 30,000.
18) Debit Computers and Printers with Rs. 25,000.
Credit Bank Account with Rs. 25,000.
19) Debit Furniture and Fixtures with Rs. 40,000.
Credit MSS Enterprises with Rs. 40,000.
20) Debit Jayesh Patel with Rs. 15,000.
Credit Sales with Rs. 15,000.
21) Debit Bank Account with Rs. 15,000.
Credit Jayesh Patel with Rs. 15,000.
22) Debit MSS Enterprises with Rs. 40,000.
Credit Bank Account with Rs. 40,000.
23) Debit Salaries with Rs. 125,000.
Credit Cash with Rs. 125,000.
24) Debit Interest with Rs. 30,000.
Credit Interest Outstanding with Rs. 30,000.
25) Debit Purchases with Rs. 25,000.
Credit James Joseph with Rs. 25,000.
26) Debit Commission Paid with Rs. 5,000.
Credit Bank A/c with Rs. 5,000.
27) Debit Bank A/c with Rs. 40,000.
Credit Cash with Rs. 40,000.
28) Debit Bank Account with Rs. 7,500.
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 Credit Interest Received with Rs. 7,500.
29) Debit Furniture and Fixtures with Rs. 50,000.
Credit Mukesh Enterprises with Rs. 50,000.
30) Debit Purchases with Rs 115,000.
Credit Bank with Rs. 115,000.

Trial Balance Exercise-1

The following account balance are observed on 31st March 20XX. Prepare a trial
balance.

Account Amount (Rs.)

Share Capital 5,000,000
Bonds 800,000
Land 1,000,000
Buildings 1,500,000
Reserves & Surplus 1,125,000
Sundry Creditors 925,000
Plant & Machinery 2,950,000
Accumulated Depreciation 1,600,000
Investments 2,000,000
Raw Materials Inventory 850,000
Work in Process Inventory 190,000
Finished Goods Inventory 1,580,000
Sundry Debtors 1,000,000
Cash and Cash Equivalent 800,000
Sales 13,250,000
Raw Materials Purchases 8,250,000
Salaries 1,000,000
Wages 500,000
Advertising Expenses 1,000,000
Depreciation 280,000
Interest Paid on Bonds 100,000
Outstanding Taxes 300,000

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 Solution

Account Debits Account Credits

Land 1,000,000 Share Capital 5,000,000
Buildings 1,500,000 Bonds 800,000
Plant & Machinery 2,950,000 Reserves & Surplus 1,125,000
Investments 2,000,000 Sundry Creditors 925,000
Raw Materials Inventory 850,000 Accumulated Depreciation 1,600,000
Work in Process Inventory 190,000 Sales 13,250,000
Finished Goods Inventory 1,580,000 Outstanding Taxes 300,000
Sundry Debtors 1,000,000
Cash and Cash Equivalent 800,000
Raw Materials Purchases 8,250,000
Salaries 1,000,000
Wages 500,000
Advertising Expenses 1,000,000
Depreciation 280,000
Interest Paid on Bonds 100,000
Total 23,000,000 Total 23,000,000

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 Trial Balance Exercise-2

The following account balance are observed on 31st March 20XX. Prepare a trial
balance.

Account Amount (Rs.)

Share Capital 1,450,000
Reserves & Surplus 350,000
Plant & Machinery (Gross
Book Value) 1,800,000
Accumulated Depreciation 500,000
Sundry Debtors 500,000
Pre-paid Insurance 125,000
Bank Loan 200,000
Sundry Creditors 300,000
Cash 325,000
Sales 1,100,000
Outstanding Wages 165,000
Wages 350,000
Salaries 450,000
Depreciation 140,000
Miscellaneous Expenses 200,000
Interest Expense 225,000
Income Tax Expense 250,000
Other Advances Received 300,000

Solution

Account Debits Account Credits

Plant & Machinery (Gross
Book Value) 1,800,000 Share Capital 1,450,000
Sundry Debtors 500,000 Reserves & Surplus 350,000
Pre-paid Insurance 125,000 Accumulated Depreciation 500,000
Cash 325,000 Bank Loan 200,000
Wages 350,000 Sundry Creditors 300,000
Salaries 450,000 Sales 1,100,000
Depreciation 140,000 Outstanding Wages 165,000
Miscellaneous Expenses 200,000 Other Advances Received 300,000
Interest Expense 225,000
Income Tax Expense 250,000
Total 4,365,000 Total 4,365,000

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