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Peter Baskerville
Course Facilitator Entrepreneurship Education at Southbank Institute of Technology Australia
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accounting, bookkeeping, business, DDS101, education, industries Based on community consensus. Sign in to add or vote for categories
KEYWORDS
credits, debits, firm, accounts, accounting concepts, bookkeeping, financial transaction, accounting system, Luca Pacioli, account group, double entry bookkeeping, duality of financial transactions.
Learning Outcomes
1 Accounting Definitions
At the completion of this training session, you will be able to answer the following focus questions: 1. What is the origin of Debits and Credits? 2. Why was it called Debit and Credit? 3. What are the underpinning concepts for Debits and Credits? 4. How would they have applied Credits and Debits in the 1400's? 5. Is there another way to look at applying Debits and Credits?
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Debits on the Left ... Credits on the Right However, there are others that want to know more about this concept of Debits and Credits so that they can apply them in a more meaningful way. If you are in the latter group, then this Knol is for you. Before proceeding, it would be very useful for both the rule-learning and concept-understanding bookkeeping students to learn off by heart the table given below and to also have a solid understanding of the definition of each account group used in the bookkeeping/accounting process. Note: One thing that is very clear is that the terms 'debit and credit', as used in bookkeeping, has its own special meaning and it should not be confused with any other meaning of the term. (i.e. Debt as in owing money to someone or Credit as in having time to pay for the purchase of goods are not definitions of the Accounting Debit and Credit) Also, the accounting meaning of a term may have a different application to the legal meaning within the same country. Table 1 - Do I DEBIT it or CREDIT it? When you INCREASE the $ amount in this account group you ... it. When you DECREASE the $ amount in this account group you .. it.
ACCOUNT GROUP
Under the Table 1 approach you would ask the following questions when ever required to record a financial transaction in the firm's accounts.
1. What accounts are involved? (There must be a minimum of 2) 2. What account group do they each belong? (They must belong to one of the five) 3. Has the financial transaction increased or decreased the $ amounts in this account? 4. Apply the table logic. 5. Make sure that the total amount $ of the debits = the total $ amount of the credits. Table 2 - DEFINITIONS ACCOUNT GROUP Asset Lay-persons definition Alternative definition Item of economic value over which the firm has legal control. Asset
Liability
Monies owed by the firm to external entities. Liability (Creditors & Loan providers) Monies owed by the firm Owners Equity to internal entities. (Investors, owners) Monies paid by others for goods and services Income provided by the firm. Assets and supplies consumed in the earning Expenses of income.
Income
Expenses
Whose Perspective? One 'credit' that worries most newcomers to accounting, is the one that appears on their bank statement. See they have just learnt that 'cash at bank' is an asset and according to Table 1 when you increase an asset you 'debit' it ... so how come the credit balance in my bank account goes up when I deposit money ... they ask. Well the answer is one that is fundamental to the accounting system. Each firm records financial transactions from their own perspective. So, think about the bank's perspective for a moment ... how do they view the money you have just deposited? Whose money is it? That's right ... it is yours! So your deposit is treated, from the bank's perspective, as a liability (money owed by the bank to others). When you deposit money into your account, THEIR liability increases which is why (using Table 1) they credit your account. The current teaching
Accountant - a qualified person who is skilled at managing and analysing business financial records. Asset - Any type of property; anything that adds value. The assets of a business are money in the bank, accounts receivable, securities held in the name of the business, property or buildings, equipment, fixtures, merchandise for sale or being made, supplies and all things of value that the business owns Authorised
OK, on with the full story about Debits and Credits ....
Most of Lucas work still underpins the accounting system we use today. Those concepts from his book in 1494 that are still
The accounting cycle The use of journals and ledgers Debits equalled credits - double entry bookkeeping The account groups of assets (including receivables and inventories), liabilities, capital, income, and expenses Year-end closing entries The trial balance, which he believed should be used to prove a balanced ledger.
#2 www.divulgamat.ehu.es
Summary In Part 1, we learned about the 500 years history of Debit and Credits and the significant contribution made to the world of accounting by the Franciscan friar and mathematician Luca Pacioli with his 'double entry bookkeeping system.
Debere (which means to owe). So, from the point of view of the firm, he could see that this principle of duality held true for every financial transaction entered into by the firm. For him, it Image source #6 - Latin Coins was not just a formula but an aspect of existence where one side could not exist without the other. In a closed system, every Debere must have a corresponding Credre and vice versa. In other words, Debere and Credre were two sides of the same coin. (In finance - when someone 'entrusts' money then someone else ends up 'owing' it') He was so convinced of this concept of duality, that he is said to declare that no one should go to sleep at night without ensuring that the credre equalled the debere. (credits = debits) The English translators used the Latin roots for these concepts and so named them Debits and Credits. It is highly probable that we also got the abbreviated forms of these terms (Dr and Cr) from the Latin roots as well, because there is no r in the English word Debit but there is one in its Latin form 'Debere'. Summary In Part 2, we see the emergence of the concept of duality where debits and credits are just two sides of the same coin in the way that the Chinese concept of 'yin and yang' are complementary opposites within a greater whole. We begin to see the concepts that underpin the application of Debits and Credits and the link to the original Latin root with its original meaning.
PART 3 - What are the underpinning concepts for Debits and Credits?
To properly understand Debits and Credits you will need to first understand the concepts that underpin the whole accounting process. Some of these are called Accounting Conventions and others are simply re-enforcing the way that the accounting systems looks at and records financial transactions.
Accounting Concept 1 The business or firm is an entity. In simple terms, the legal system defines an entity as a person or non-person that is capable of suing or being sued under the laws of the land. In most countries of the world, companies are given this non-person entity status and are given the same rights and obligations of individual persons. Accounting takes this concept a step further by stating that every firm (including sole traders and partnerships), creates its own accounting entity and that the income and net worth of each entity must be calculated based on its own financial transactions.
Accounting Concept 2 The business (firm) is a separate entity distinct from the owners A firm, while it has 'legal' control over items of value, it is not the ultimate owner of those things. In other words, if the firm sold everything it had, it would be obliged to distribute all those monies to meet the claims made by other people or entities. The firms first obligation is to pay the claims made by external people (i.e. loans and creditors) with the balance being given to meet the claims made by the owner(s). The business would then return to how it all began, as a blank sheet without obligations or the control of any items of value. Accounting Concept 3 People can wear multiple hats. While this a not a strict accounting concept, it is an important one to understand when getting the right perspective on financial transactions. Just like one person can be a parent, sibling, cousin or an offspring, so too a person can be an investor in a firm, a creditor/debtor of a firm, the manager of a firm or a director of a company that controls the operations of a firm. The important thing to remember is, that in accounting the financial transactions are always analysed and recorded from the firms point of view with you as the manager (not owner). Accounting Concept 4 Every financial transaction has two sides to it. The financial world is a closed system. That is, money does not just arrive from nowhere. If money is received by one person or entity, it must have been given by another person or entity. This gives us our first insight into the Debits and Credits system that we use in accounting today. Accounting Concept 5 The profit from the firm's activities belongs to the owners. As understood from Concept 2, the firm does not really own anything, from an accounting perspective. It may have legal rights of ownership or control, but fundamentally in accounting terms it is an accounting entity set up by the owners to manage their affairs. So, when a firm makes a profit it does so for the owner's benefit, not for the firm's. Remember, if everything was sold off the firm would be left with nothing because everything of value would be used to first pay off liabilities with the remainder going to the owners.
www.wordle.net - Debits and Credits Summary In Part 3, we get to understand the accounting concepts that not only underpin the concept of Debits and Credits, but the whole accounting system as well. We learnt that; 1. The business or firm is an entity. 2. The business (firm) is a separate entity distinct from the owners 3. People can wear multiple hats and operate in multiple capacities. 4. Every financial transaction has two sides to it. 5. The profit from the firm's activities belongs to the owners.
PART 4 - How would they have applied Credits and Debits in the 1400's?
As Lucia pointed out, the accounting system he documented was being widely used by the Venetian merchants. These people seem to be the 15th century entrepreneurs. Lets say that a Venetian entrepreneur named Antonio asked Lucia to record the financial transactions of his new business (firm) prior to Luca completing his famous Summa book in 1494. (Note: For the purposes of this story we will use the $ rather than the Venetian ducat or Florence's famous fiorino d'oro 'golden florin' and use the English accounting terms rather than the Latin)
The story goes ... Antonio had spotted an opportunity to sell Italian olives to Egypt. Antonio thought he could make a killing. So, Antonio (as manager of the new firm) approached an Italian olive provider and convinced him to supply $100,000 worth of olives but with the promise to pay him on his return from Egypt. Antonio did not mention the profit he was going to make because the olive providers only interest was in being paid for the olives. So, Lucia had his first financial transaction, and noted the following using the Latin meanings for Debits and Credits: The firm had increased its obligations to the Italian olive producer because the producer had entrusted $100,000 to the firm in the form of olives - Credit (Cr) and The firm was now in possession of Olives which it could use (sell) to repay the obligation (what it owes) to the Italian olive producer $100,000 Debit (Dr) Using the Table 1 approach we would make the following entry: Asset - Stock (increase) Liability - Accounts Payable - Olive Provider (increase) $100,000 Dr $100,000 Cr
Soon after, Antonio took Luca to see the $50,000 ship he had bought, using $30,000 of his own money and $20,000 from a bank (loan funds). Antonio was excited because he now knew that he had the means to make his idea a reality and make that fortune he dreamed of from selling these olives. Luca realised that while Antonio was always speaking about what he had done, Luca knew that he was really speaking about what the firm had done with Antonio as its manager. Luca realized that the firm had been involved in its second financial transaction and again noted the
following from the firms point of view: The firm had increased its obligations to the bank because the bank had entrusted $20,000 to the firm in the form of a loan - Credit (Cr) and The firm had also increased its obligations to the Antonio (as owner) because Antonio had entrusted $30,000 to the firm in the form of Capital - Credit (Cr) and The firm was now in possession of a Ship which it could use, if it chose to sell it for $50,000, to repay the obligation (what it owed) to the bank and to Antonio Debit (Dr) Using Table 1 approach we would make the following entry Asset - Ship (increase) Liability - Bank Loan (increase) Owners Equity - Capital - Antonio (increase) $50,000 Dr $20,000 Cr $30,000 Cr
Luca was happy because in both financial transactions the total of the debits equalled the credits and the underlying concepts of the 'double entry bookkeeping' system had been adhered to. Summary Armed with the underpinning 'double entry bookkeeping' concepts and his Latin definitions of Debit and Credit, we attempt to see what Luca saw as he contemplated the entries that would be made in the fictitious books of the 15th century entrepreneur, Antonio.
'Obligations Approach' to applying Debits and Credits ... on with the story. Antonio was soon back in town after successfully completing his sales trip. Antonio explained that he (as manager) had sold all the olives for $200,000 and the trip had only cost $30,000 including the $1,000 interest he paid to the bank. He explained that he had paid these amounts out of the sale proceeds and that he had visited the Olive provider to repay his account. He also said that he had used $10,000 of the sales proceeds to buy furniture for his house in celebration of a successful trip. We soon realise that a third series of financial transaction for the firm has happened involving five main
parts. Part Part Part Part Part 1 2 3 4 5 The sale of the olives for $200,000 cash The use of the $100,000 of olive stock to create the income of $200,000 The Olive provider was paid for his outstanding account. - The use of $30,000 of cash proceeds to pay for the trip costs and interest expense - The withdrawal and use of $10,000 by Antonio (as owner)
Taking over from Luca, we will look at these transactions and apply the obligations approach to determining the Debits or Credits of the transaction - always remembering to take the obligation of the firms point of view. Here is what we would have come up with; Action by the firm Transaction PART 1 The firm had (A) the firm had increased received $200,000 in its capacity to repay future Debit (Dr) cash for the sale of obligations the olives (B) the firm has increased its obligations to Antonio (as owner) because sales Credit (Cr) are potential income which the firm ultimately owes to the owners (investors) Cash (Asset - increase) Obligation Option Affected Dr/Cr $ Account & Group
$200,000
Transaction PART 2 The firm no longer had the olives, because they have been sold (D) the firm had reduced its capacity to repay future Credit (Cr) obligations Stock (Asset - decrease)
$100,000
(C) the firm has decreased its obligations The firm had used its to Antonio (as owner) purchase of the because the income due olives to make the to the owner has been sales proceeds reduced by the cost of purchasing the olives Transaction PART 3
Debit (Dr)
$100,000
The firm paid the (C) the firm has reduced outstanding promise its obligations to the Olive Debit (Dr) to the Olive provider provider The firm used its (D) the firm has reduced cash from the sale to its capacity to repay future Credit (Cr) pay the Olive obligations provider. Transaction PART 4 (C) the firm has reduced its obligations to Antonio (as owner) because the income he was to receive has been reduced by the cost of the sales trip
$100,000
$100,000
The firm had to pay for the costs of the sales trip
Debit (Dr)
$29,000
(C) the firm has reduced its obligations to Antonio The firm had to pay (as investor) because the for the interest costs income he was to receive to the bank has been reduced by the interest expense The firm had to pay
Debit (Dr)
$1,000
cash for the travel (D) the firm has reduced costs, including its capacity to repay future Credit (Cr) interest, from the sale obligations proceeds Transaction PART 5 Antonio (as owner) used $10,000 of the firm's cash for personal use. (C) the firm has reduced its obligations to Antonio (as owner) because he Debit (Dr) has already taken a share of the profits that were due to him. (D) the firm has reduced its capacity to repay future Credit (Cr) obligations
$30,000
$10,000
$10,000
All the account groups have been affected in this transaction, yet you can see that we still achieve the same outcomes as the learned-Table 1 approach, but there is an underlying meaning to the questions and they are in keeping with Luca's original Latin meaning. Summary In Part 5, we explore the idea that all financial transactions could be interpreted from the point of view of the firm's obligation. Having just two main questions, we are able to apply a different and more meaningful approach to determining a Debit entry in to the firm's books, or a Credit one. We have attempted to link this approach to the likely meaning that Luca Pacioli had for the terms Debits and Credits. So, apart from learning and applying the logic of the Table 1 approach to your debits and credits, you could also apply this alternative view developed from the first principles of Luca Pacioli's work using the Latin Debere = 'to owe' and Credre = 'to entrust'
Additional Resources:
1. For an overview or introduction of Debits and Credits see: Bean Counter's Accounting and Bookkeeping "Cheat Sheet"l 2. For another series of lectures on the topic Debits and Credits see: Stamford online.com Lecture 3. For a glossary of terms on Accounting Terms see: Utah Association of CPAs
1. To understand the origins of the terms Debits and Credits 2. To understand the reason it called Debits and Credits 3. To identify and comprehend the underpinning accounting concepts for Debits and Credits 4. To see how would they have applied Credits and Debits back in the 1400's. 5. To find a meaningful way to apply Debits and Credits to financial transactions. We set out at the start of this Knol to understand more fully the concepts of Debits and Credits. We know that we can be a successful bookkeeper by simply applying the learned Table 1 approach, but some people want to understanding the 'why'? By going back to the time of its conception, and looking at the original meanings we have been able to give meaning and a new approach to determining the Debits and Credits of financial transactions. If you had difficulties understanding any of the parts, then it is recommended that you link to the Additional Resources, as these may help you to understand them. If you have further questions you could post a question to the website Ask the Accountant.
The key learning from this session included the origins of the terms Debits and Credits, the reason they are called Debits and Credits, the underpinning accounting concepts for Debits and Credits, the application of Debits and Credits back in the 1400's and the discovery of a new meaningful way to apply Debits and Credits to financial transaction. This knowledge will underpin the next learning level, which deals with the accounting equation and financial statements (not yet posted).
Click HERE For Accounting Definitions Click HERE for Breakeven Education Reference & Image Source
Image Source #1 - by closelyobserved.com CC Atrtribution 2.0 ttp://www.flickr.com/photos/soylentgreen23/155041332/ Image source #2 - DivulgaMAT: Centro Virtual de Divulgacin de las Matemticas de la Real Sociedad Matemtica Espaola www.divulgamat.ehu.es Image source #3 - CC Atrtribution 2.0 wikimedia.org_Luca_Pacioli Image source #4 - CC Atrtribution 2.0 http://en.wikipedia.org/wiki/File:Leonardo_polyhedra.png Image source #5 - CC Atrtribution 2.0 http://www.bestwebbuys.com/AccountingISBN_9780324376159.html?isrc=b-search Image source #6 -CC Atrtribution 2.0 http://www.luc.edu/classicalstudies/academics.shtml
Peter Baskerville is a lecturer, educational My Accounting Knols resource developer and entrepreneur. He has authored courses in post graduate education in entrepreneurship for the Queensland Education Department TAFE and developed teaching resources for IBSA the Commonwealth Government's vocational skill authority. He has lectured at Southbank Institute of Technology, private RTO's and been a guest 1 Define Accounting lecturer with indigenous organisations as well as mentoring 2 Debits and Credits Brisbane City Council multi-cultural scholarship winners. He hold interests in businesses operating in the hospitality and educational 3 Break Even resource development sectors.
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Quite Detailed
Thanks!
Ann P
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many many thanks to u for diply knowledge in accounting
Anonymous
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thanks for deep explanation