Comment by ffsm8
1 year ago
Being able to explain it is something different then you being able to understand it.
And double entry bookkeeping should be both easy to explain (there are countless articles for it, precisely because it is a pretty easy concept) And easy to understand if you have ever tried to keep a ledger of transactions around and wanted to audit it for errors.
I always get hung up on the different kinds of accounts and their respective definitions of "credit" and "debit". It isn't that much to memorize but it's very counter to the way I understood those terms and it keeps throwing me off.
The simplest way to memorize it is to remember the accounting formula and one simple rule.
- Assets minus Liabilities = Equity (net worth)
- Your bank account or cash balance increases on the debit side
From this you can figure out that if you borrowed money, the debt increases on the credit side and the cash influx debits your bank account. The same goes for an income.
But signed amounts (instead of debit/credit) formula is a way easier.
Sum of entries of assets/liabilities accounts = Equity. Moreover assets and liabilities become one type.
3 replies →
Surely it credits my bank account. Credits make things go up, no?
Clearly not. But this is why I let an accountant do it.
4 replies →
This is a bit late, but I don't see any other answers that provide what I think is the key insight.
The accounting equation is: Assets = Equity + Liabilities.
For a transaction to be valid it needs to keep that equation in balance. Let's say we have two asset accounts A1, A2 and two Liability accounts L1, L2.
A1 + A2 = Equity + L1 + L2
And any of these sorts of transactions would keep it balanced:
(A1 + X) + (A2 - X) = Equity + L1 + L2 [0]
(A1 + X) + A2 = Equity + (L1 + X) + L2 [1]
(A1 - X) + A2 = Equity + (L1 - X) + L2 [2]
A1 + A2 = Equity + (L1 + X) + (L2 - X) [3]
Now, here is the key insight: "Debit" and "Credit" are defined so that a valid transaction consists of the pairing of a debit and credit regardless of whether the halves of the transaction are on the same side of the equation or not. It does this by having them change sign when moved to the other side.
More concretely, debit is positive for assets, credit is positive for liabilities. And then the four transaction examples above are:
[0]: debit X to A1; credit X to A2
[1]: debit X to A1; credit X to L1
[2]: credit X to A1; debit X to L1
[3]: credit X to L1; debit X to L2
You can debit and credit to any arbitrary accounts, and so long as the convention is followed and debits and credits are equal, the accounting equation will remain balanced.
Another way of looking like this is with parity. A transaction consists of an even parity part "debit" and an odd parity part "credit". Moving to the other side of the equation is an odd parity operation and so a credit on the RHS has double odd parity, which means it adds to those accounts (and debit, with odd parity, subtracts).
most accounting software chooses one convention and sticks with it on all account types, to the chagrin of accountants