Debits? Credits? Debtors? Creditors? Let’s call the whole thing off.
Before we get to the nub, can we sort out debtors and creditors? Many people confuse the two, which is understandable because “debtors” sounds like “debts” and this is misleading. Try this. “Creditors are cruel because they will sue you or send a man around if you don’t pay”.
This leaves debits and credits. A client said to me “Expenses are bad. You want to have as few as possible. Assets are good. You want as many as possible. Why are they both debits?” Good question. The client might equally have said “Revenue is good. You want as much as possible. Liabilities are bad. You want as few as possible. Why are they both credits?”
The answer is that there is no direct, deep or meaningful relationship between expenses and assets or between revenue and liabilities. They arrived at their respective destinations using different routes.
It helps to know that there is no logical reason why assets should be debits. It is simply the toss of a coin. Long ago, an unknown person labelled assets as debits and this has stuck. Ever since, assets and expenses have been debits while revenue, liabilities and equity (ownership) have been credits. However, if you toggle one, you have to toggle them all. Incidentally, if we did toggle, we would now be saying that assets are credits, with the result that a million accountants (especially the males) might have to find employment elsewhere.
Let’s work with an example. Pig in Mud Pty Ltd is a brand-new company. It is owned by Ima Grunter. Ima provides advisory services to business. Her first assignment earns her $1,000, which is paid on completion. In order to operate, Ima had to purchase office supplies for $200. These are the only two transactions to date.
Back in the day, a bookkeeper might have recorded these as follows
Date Name Amount Description
14 March 1415 Building Bros $1,000 Income for advice rendered
14 March 1415 Paper and Quill suppliers -$ 200 Office Supplies
This is single entry bookkeeping. It is cumbersome and prone to errors. Double entry bookkeeping was introduced about 500 years ago and took over the world. The underlying principle is that the amount of every transaction must be entered in two different ledger accounts. For example, the income of $1,000 above might be entered once in an asset account called Cash at Bank and a second time in a revenue account called (perhaps) Professional Services Income. To get the benefits of double entry bookkeeping, the amounts entered must be equal and opposite so that the total of all entries balance to zero or, to put it another way, total debits equal total credits. Debits and Credits could have. and probably should have, been labelled Positive and Negative or Plus and Minus but the originators unfortunately chose the more confusing words Debit and Credit, which were derived from some now obscure Latin words.
Entering each entry twice and on opposite sides of the ledger is simply the device that makes double entry bookkeeping sensational. If Bank Account is debit, the equal and opposite entry to revenue has to be credit. There is no mystique.
On the other hand, assets are what you own and liabilities are what you owe. The relationship is clear, nose on your face. If an asset is debit, a liability must be credit.
In summary, revenue came to be a credit simply so the books would balance and liabilities became a credit because they are the opposite of assets. There is no direct relationship. At best they are second cousins.
Now, finally, you can sleep peacefully tonight. Accounting is simple. That is why there are only 7692 pages of Generally Accepted Accounting Principles. Most of these are related to the accountant’s worst enemy, even worse than cash.
Time.
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