Comment by mrkeen
2 years ago
> Double-entry bookkeeping is very easy to understand once you ditch the ridiculous "credit" and "debit" terminology.
I'm with you so far.
> the goal is to keep the accounting equation true at all times
Perfectly reasonable.
> For example, you sell a lemonade for $5. You add $5 to Sales (Income) and add $5 to Current Account (Assets).
And now you've completely lost me. Money appeared. Lemonade disappeared. I want to see the corresponding +$5 and -$5.
Making it fit the equation (Equity + Income + Liabilities = Assets + Expenses) is not an intellectually satisfying reason for 'Assets' to go up by $5 when I just lost $5 of assets.
What if it worked this way in physics?
I could write
Force * mass = acceleration
1N * 500g lemonade = 0.5 m/s/s
Then I could say: "If we halve the mass of lemonade, then we double the acceleration:"
1N * 1000g lemonade = 1.0 m/s/s
And then you could say "But you didn't halve the mass, you doubled it!" and then I could say "Yes I did, look, the equation still holds."
> Money appeared. Lemonade disappeared. I want to see the corresponding +$5 and -$5.
If I understand your comment correctly, where you're getting confused is, you're reading Current Account (Assets) to mean your inventory of lemonade. What they actually mean in this case is money moved from Income to your Assets (e.g. your cash register). That's why assets went up in this example.
Of course for your lemonade business you might keep track of your lemonade as well (which I think is what you're talking about when you refer to assets). The lemonade sale would then lead to a decrease in your lemonade asset and and an increase in your expenses (cost of goods sold), so the right hand side of the equation balances.
So when selling lemonade there are actually 2 things happening:
1. Your income and your assets (your amount of cash) both increased. Income and Assets are on different sides of the =, so the equation still balances
2. Your lemonade assets decrease and you incurred the cost of that lemonade as an increase of your expenses. Those are both on the same side of the =, so the equation still balances.
Thanks for moving this along.
I knew beforehand that I will always get Credit and Debit wrong, but now I guess I can add Income and Assets to that.
> What they actually mean in this case is money moved from Income to your Assets (e.g. your cash register).
Usually when people say 'moved', it implies a decrease in one place and an increase elsewhere, and yet:
> 1. You got income and your assets (your amount of cash) both increased.
> Usually when people say 'moved', it implies a decrease in one place and an increase elsewhere, and yet
Yeah, I'm with you there. Personally I think this would be simpler if accounting just used negative numbers instead of a credit and debit side. That said, it's not super complicated. It's all derived from the accounting equation (explained well in this comment [1]):
Equity + Income + Liabilities = Assets + Expenses
Any transaction you do, needs to maintain that equation. That means that the changes either need to add to zero on one side or need to add to the same on both sides.
- E.g. in the example I'm selling lemonade: I'm increasing my cash (an asset, so on the right side) by $5, so I need to also increase the left side by the same, meaning an increase of $5 in the Income account.
- Or let's say I'm buying more lemons for my business. My cash (asset) goes down, but my inventory (also asset) goes up by the same amount.
- If I bought those lemons with my credit card instead, my inventory (asset) would go up and my liabilities would go up by the same amount.
In all cases the equation still holds after the transaction.
----
NB
You could construct an alternative way of accounting where the equation looks like this: Equity + Income + Liabilities + Assets + Expenses = 0
In this world, moving money would indeed align better with your intuition. E.g. selling lemonade would be -5 Income and +5 Assets (going from income to assets). That's for instance how Beancount does it [2]. Note that that also means that Equity, Income and Liabilities will now (generally) be negative numbers.
[1] https://beancount.github.io/docs/the_double_entry_counting_m...
The -5 doesn't belong in your ledger, it belongs in the ledger of the person who bought the lemonade. As other commenters have pointed out, the "double entry" refers to multiple entries within your own ledger, it has nothing to do with someone else's ledger.
> The -5 doesn't belong in your ledger, it belongs in the ledger of the person who bought the lemonade.
This is just prescriptive (do it because I say so). It doesn't explain anything.
> As other commenters have pointed out, the "double entry" refers to multiple entries within your own ledger, it has nothing to do with someone else's ledger.
I didn't introduce the other guy's ledger, but since you did:
I lost lemonade (which is somehow an addition to my assets). So the "-5" which belongs in the buyer's lemonade - is the negative sign there to indicate that he gained an asset?
Inventory is an asset, so if you want to account for inventory in this example, you would record two debits and two credits:
- $5 debit to cash (asset => debit means +5)
- $5 credit to revenue (equity => credit means + 5)
- $X debit to cost of goods sold (liability => debit means - X)
- $X credit to inventory (asset => credits mean - X)
Where X is the cost of the materials that went into the lemonade. So if X < 5, you made a profit. In terms of the equation, this comes out to:
So it all adds up to 0, but you make a (gross) profit or loss depending on the value of X.
You wouldn't account for the customer's side of things because the customer is not on your books.