Double-entry bookkeeping is an anomaly. So few of the world’s population understand it, or even knows it exists, however, without it, the world would not be able to operate as it does today. The majority of the world’s people, especially in developed countries, are aware of the use of accountancy within all kinds of organizations, whether they be commercial, governmental, charitable or any other kind of enterprise involving the use of money. However what percentage actually really have any idea of how it works?
Account Types
Accountants produce accounts of several different types. Accounts to help run their organization as efficiently as possible, accounts to meet conditions set down by governments, accounts to satisfy the requirements of taxation authorities and, in larger enterprises, accounts to keep shareholders and other interested outsiders informed of how well the organization is operating. So what makes a good accountant?
The Basic Skill Of An Accountant
The majority of the world’s population understands that the main basic skill of a house builder is bricklaying, and that the main basic skill of a successful author is an above average skill in the art of writing. However, what percentage of the world’s population knows what the basic skill of an accountant is? A small minority, I would suggest.
So let me enlighten you. The basic skill of an accountant is the art of double-entry bookkeeping, which first evolved in Italy, late in the 15th century. Despite its age, double-entry bookkeeping has proved its longevity and it is still the basis of all manual accounting systems, as well as all computerized accounting software available today. From the most simple system, to the most sophisticated, double-entry bookkeeping is used to control the finances of billions of enterprise around the world, from the smallest corner-store to the World Bank.
Without double-entry bookkeeping, the world could not operate as it does today, but, despite its importance, only a very small proportion of the world’s inhabitants have any idea of how it works and a huge percentage of the world’s population doesn’t even know that the term exists.
Why The Need For The Word ‘Double’?
So why is this ancient art called “double-entry bookkeeping”? Why not just call it “bookkeeping”? If an accountant needs to record a transaction, surely that’s what he or she does? He or she records a transaction. Why is there a need for the word “double”? The answer lies in the fact that all transactions in fact affect two or more aspects of the enterprise, so that two or more entries are required. One or more are called “debits” and this amount, or the total of these amounts, will be matched exactly with the total of the amount or amounts “on the other side” which are called “credits”. Here are some examples:
When a business makes a sale
The sale may be for cash or it may be on credit. If the sale is for cash it has to be recorded that the total sales made have increased (a credit), and also that the total cash owned by the entity has increased (a debit). If the sale is on credit it has to be recorded that the total sales made have increased (a credit), and also that the customer now owes the entity money that has to be collected in the future (a debit).
When a business purchases something
The purchase may be goods for resale or one of the business’s many overheads, electricity for example. The person in charge of the relevant department may pay for it with cash, meaning probably a check, but nowadays it is more and more likely that the payment will be transacted in some way over the internet. Whatever the case my be, the accounting department has to record not only the amount and nature of the purchase (a debit), but also the fact that the institution’s cash reserves will have diminished (a credit). However, if the entity has a credit account with the supplier, or the supplier issues an invoice payable within a certain time frame, then again not only the amount and nature of the purchase has to be recorded (a debit), but also, in this case, that the organization now has a debt, which must be paid sometime in the future (a credit).
The cost of an asset, a motor vehicle for example
The total cost should be spread over the expected life of the asset. This is called “depreciation”. When depreciation is calculated and entered into the records, there is again two entries to make. The value of the asset is reduced by a calculated amount, depending on the time the depreciation is being calculated over (a credit), and an equal amount will be charged to an account which will reduce the organization’s profit, or increase its loss for the period under review (a debit).
Often transactions involve more than two entries
In all cases the total of the values (not the quantity) of debit entries must equal exactly the total of the values of the credit entries. If something large is purchased using a bank loan, lease, or other form of finance the total owing will be recorded (a credit) and this will be “balanced” by 2 debits. The basic cost of the asset and the total interest payable as stated in the agreement. This is known as “Prepaid Interest”. As the regular payments are made, say from he entity’s bank account on a monthly basis, the organization’s bank account will be reduced (a credit) and the total owing will be reduced (a credit). However, in addition the total payment will be divided proportionately into a repayment of basic debt and a payment of interest. The interest portion will be a decrease to the reported profits, or an increase to the reported loss (a debit) and the “Prepaid Interest” account will be reduced by the same amount (a credit).
Conclusion
There are a million other examples but, in each case, more than one category needs to be adjusted. Double-entry bookkeeping is a skill that more people, especially small business people should be much more familiar with. Don’t you agree?