What is Direct Credit?
Direct credit is a monetary deposit made into the account of any person, business, or other entity, mostly by means of an electronic funds transfer in a faster, easier, and more convenient manner than other forms of transfer.
How Does it Work?
- Whenever the payer makes a direct credit into the account of the payee, the related bank gets a notification of such a transaction. In this case, the bank will record the amount by which the payee’s account is credited as soon as the transaction is made. However, there will be a difference in the books of accounts of the bank and the payee.
- The payee will record a transaction of deposit, in this case, only when he receives bank intimation of credit. The bank, on the other hand, shows a higher balance as it receives the amount ahead of the payee. Further resolution to such differences is subject to reconciliation of statements.
Example of Direct Credit
Assume a cloth business accountant pays his supplier $5,000 every month for the purchase of packaging. He does that on the 1st of every month through direct credit. Let’s suppose it is the 31st of March today, and the money will be credited to the supplier’s account tomorrow. The bank account of the supplier will look like this:
- Date: 3.31.2020
- Account balance: $1,00,000
Upon credit, the account will look like:
- Date: 4.1.2020
- Credit: $5,000
- Account Balance: $1,05,000
The supplier will make a reconciliation entry into his books of accounts to realize the income which has been received through a direct credit. The entry will look like this:
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- Bank account debited by $5,000
- Purchase account credited by $5,000
Uses and Importance
These systems are used worldwide with prominent ones ACH (Automated Clearing House) network of the United States and the Australian direct entry system.
#1 – U.S.A.
- ACH is the national clearinghouse of the U.S. that operates on automation. ACH functions in both direct credit and direct debit. Nationwide, payments are made through this system, but a large chunk of transactions are related to payroll and social security. ACH networks held a cumulative $50 trillion worth of monetary payments in 2018.
- Some of the main usages the ACH is put to are eCommerce payments, social security-related benefits, tax refunds, business-to-business payments, rents, consumer bills, etc.
#2 – Australia
- Australia uses a direct entry system as a means of direct credit fund transfer. The Australian body for clearing and settling transactions on electronic systems is the APCA (Australian Payments Clearing Association). The system uses a BSB and account number that is made for a unique set of combinations for accounts. Apart from this, the Big Four banks in Australia use a BPAY bill payment system among them, which is not regulated by APCA.
- The system brings in cost synergies in more than one way. Banks and institutions using direct credit have gained immensely by cutting on excessive staffing and training needs. The paperless system also allows for greater flexibility and easier storage (electronic nature).
- It is a faster and easier method of money transfer.
- These transfer methods also save time and other costs like processing, conveyance, and printing charges.
- Direct deposit methods also come with automation that allows an automated deduction from one account to credit the other desired account.
- There is no need to visit banks to deposit money, thus saving a lot of paper and physical toil.
- In cases where government organizations or companies/employers must credit the payees’ accounts periodically and regularly, direct credit becomes a preferred choice.
- There are very few disadvantages to direct credit. However, in case if a person has overdrawn his account, the periodic money deposit will be used by banks or financial institutions to cover the overdraft.
- It should be noted that it comes with the limitation of characters and size, which is why the payer involves remittance advice upon transaction. It helps in easy recognition for transactions as well as any meaningful reference code that establishes a unique relationship between the two parties.
- Most commonly, references are account numbers, purchase invoice numbers, national identification numbers, and identification codes.
- Many employers have an all-electronic system to pay their employees, suppliers, etc. Direct credit comes with many advantages and has gained popularity among businesses. This system of fund transfer helps avoid missing payments and onus of keeping up with regulations as the banking institutions involved are prepared to take care of such issues.
- It is vital to the operations of banking and financial institutions, including governmental and non-governmental bodies, as it has successfully borne the load of voluminous payments taking place all around. These are purposeful when the transacting parties have sufficient know-how of each other, and the payer has the discretion of payments without payee involvement.
This article has been a guide to What is Direct Credit & its Meaning. Here we discuss the example of direct credit and how does it work along with uses & importance, advantages, and disadvantages. You can learn more about from the following articles –