Which of the following statements is true regarding debits and credits?
a. On the income statement, debits are used to increase account balances, whereas on the statement of financial position, credits are used to increase account balances.
b. The basic equation on the statement of financial position is Assets + Liabilities = Equity.
c. The rules for debit and credit and the normal balance of Share Capital – Ordinary are the same as for liabilities.
d. On the income statement, revenues are increased by debit whereas on the statement of financial position retained is increased by a credit.
The correct answer and explanation is :
Correct Answer:
c. The rules for debit and credit and the normal balance of Share Capital – Ordinary are the same as for liabilities.
Explanation:
In accounting, debits and credits follow specific rules depending on the type of account. The normal balance of an account is the side (debit or credit) where increases are recorded.
Understanding Debits and Credits:
- Assets (e.g., cash, accounts receivable, inventory): Increased by debits, decreased by credits.
- Liabilities (e.g., accounts payable, loans payable): Increased by credits, decreased by debits.
- Equity (e.g., share capital, retained earnings): Increased by credits, decreased by debits.
- Revenues (e.g., sales, service revenue): Increased by credits, decreased by debits.
- Expenses (e.g., rent expense, salaries expense): Increased by debits, decreased by credits.
Share Capital – Ordinary is an equity account, and equity accounts have the same normal balance as liabilities. Both are increased by credits and decreased by debits, making option (c) correct.
Why the Other Options Are Incorrect:
- Option (a): Incorrect because on the income statement, revenues are increased by credits, not debits.
- Option (b): Incorrect because the correct accounting equation is Assets = Liabilities + Equity, not “Assets + Liabilities = Equity.”
- Option (d): Incorrect because revenues are increased by credits, not debits. Also, retained earnings (part of equity) are increased by credits, but the wording in the option is misleading.
Thus, the correct answer is (c), because Share Capital – Ordinary follows the same debit and credit rules as liabilities.