Abbreviation for Credit:
The term credit was derived from the Latin term ‘Creditum’ which means to entrust or something that is entrusted. Its abbreviation is ‘Cr’. Therefore, a credit shows that an obligation is due to another party. Credit is as important a part of financial statements as debit is.
Invented by the father of accounting, Luca Pacioli developed double-entry accounting, which led to the establishment of the credit balance system alongside the debit. No financial statement is complete without the two correspondings to one another.
Credit is made in the right-side column of a financial statement. The lender is either supplying raw materials, service, funds, or security in exchange for an equal debit, which can also be in the form of a payment or service rendered to the crediting party in a transaction. In such transactions, interest is also associated in order to give incentive to the creditor for supplying the said credit balance.
Credit in Accounting:
In accounting, credit is recorded as an increase of liabilities or shareholders’ equity denoted as Cr. The increase of liabilities is a credit amount as this is the debt owed by the borrower to the creditor resulting in liability.
In business practices, credit is always recorded on the right-hand side of the general ledger indicating that it includes all the credit balances belonging to the company while the left denotes the debit balances.
The more entries are made into the right column, the more the credit balance increases against the debit balance offsetting the financial statement. Credit balances recorded for liabilities, revenues, and stockholder’s equity accounts increase the credit balance while decreasing the debit balances that increase assets and expenses.
An example of a credit balance is as follows:
An individual owes their bank $5000 but returns a purchase worth $3000 on the credit account. This would reduce the outstanding credit balance to $2000. Meaning that ultimately the individual has to pay only the remaining credit amount of $2000 to the bank.
Similarly, businesses may choose to take credit loans in order to vamp up their production so that they can pay back the loan over time as the business generates greater profit margins and becomes an industry leader with the help of funds borrowed.
Credit in T-Account:
Credit in T-account is noted on the right-hand side of the column outstanding as the amount that is to be paid up.
Credit balances are also given by institutions to fund the government as well as private activities, which can include operations, expenditures, and projects. Commercial banks are the best and the oldest example when it comes to lending credit balances at a set interest rate. They supply the loan as a credit balance receiving interest over time for the said credit.
These balances are given based on a specific set of requirements that proceeds to judge both the character of the individual or entity borrowing the balance as well as their credibility in being able to repay the loan. In most cases, collateral is also kept as a contingent in case the borrower is unable to repay the initial capital or the interest amount. When these obligations are fulfilled, the collateral is given back to the borrower.
In banks, a credit could mean an increased capital in your bank account allowing you to spend more than your current income. As your bank balance increases, the bank’s obligation and liability to you also increases.
In this way, credit may refer to loans, letters of credit, credit ratings, and so on.
How Credit Works:
In practical business settings, the most common use of credit is in its referment to an agreement that pays off later. This is known as buying on credit. The most common way that you can use credit is to buy products or services using a credit card.
This financial instrument allows you to take a loan and use that loan to pay off whatever needs you to want to be fulfilled, having to pay back that loan at a certain time period with significant interest on it.
Credit cards allow banks to serve as the intermediary that is extending their credit funds to individuals using the card to take immediate loans that they can pay off at the end of the month.
Another use of credit is to authenticate the credibility of an individual or institute. The term, credit can therefore be used accordingly such as, “This person has great credit with the local bank” insisting on the individual’s trust with the bank following his reputation of always paying back his/her credited loans.
Lastly, credit is used in accounting as part of the double-entry system that notes both the decrease in assets or expenses as well as the increase in liabilities and revenue. Meaning that while debt reduces a company’s net income, credit on the other hand increases it.
Types of Credit:
Credit comes in different forms and types. The four most common ones are as follows:
- Charge Cards
These are cards issued by retailers to be used at their retail stores only. These cards may allow you to gather points instead of balance, and once you accumulate a certain number of points you may be rewarded with discounts or free items.
- Service Credit
Most companies charge you for your monthly expense after you have already used their services. An example of this can be your electricity, gas, and water or gym membership. These are paid after the services have already been used and rendered.
- Installment Credit
This is most commonly found in commercial banks where you take a loan of a specified amount that you agree to pay such that the amount borrowed and the interest amount is paid at the end of the tenure. These payments are set up monthly so that the individual or entity has to pay credit at the end of the month. Example of this includes student loans, car leasing, and mortgages.
- Revolving Credit
It allows you to make changes up to a certain limit allocated to you, which is your prescribed borrowing limit. Having to pay a minimum amount of fee each month for the outstanding charges up to the full amount. An example of this is a credit card.
A Review of Credit in Accounting:
Credit is the act of owing a debt to a creditor that has to be paid later often with an added interest. There are many reasons why someone would use credit to avail its advantages and employ its use in their business or daily lives.
Credit in accounting is the art of recording it in the double-entry system on the right-hand side of the financial statement in contrast to the debit accounts found on the left-hand side. The debit and credit accounts should cancel each other out such that they create an equal balance of accounts.
The credit increases your liabilities while decreasing your assets therefore, it is a good idea to have less credit than debit in your financial statements reflecting the overall health of your business. Recording credit is equally important as it allows you to assess the financial situation of your business accordingly.