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1987-03-02
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Experienced bookkeepers and accountants need not review the material
immediately following. Page down to the section beginning "Your Chart of
Accounts".
History
-------
The German romantic poet Goethe said that double entry bookkeeping is
beautiful and elegant. It is all of that and more, probably the most
powerful, yet simplest, bit of lateral thinking ever conjured up by the human
imagination. It allows a people with no formal concept of zero or negative
numbers to indulge in the most complex of financial dealings -- piracy, trade
and empire.
Double entry bookkeeping as we know it probably appeared in the great Islamic
civilization of the 10th or 11th Centuries. Conceivably, the Arabs introduced
it into Europe through Spain, along with algebra, the zero, and modern clocks,
at about the time of Ferdinand and Isabella, just prior to the Renaissance.
But earlier... Did Omar Khayyam puzzle over double entry bookkeeping? He
knew about closing an account in 1123 A.D., if we can trust Fitzgerald's
translation of the Rubaiyat! And he wrote the first Arabic book on algebra.
Did he or some other astronomer-mathematician INVENT algebra as a way to
explain to the poobahs of the Persian court how double entry actually works?
I don't know, but I'd like to think so. I think double entry bookkeeping came
first, and suggested algebra to the quick-witted sometime later. But Omar
Khayyam, vizier to the Caliphs of Persia, knew about it in the 12th Century.
Modern accounting PRACTICE, on the other hand, dates only from about the 16th
Century, or about the time of the Borgias.
This leads us to a very brief tutorial
--------------------------------------
Double entry bookkeeping is designed to show the ownership of assets. That's
ALL it does. Once you've caught on to that, the rest is easy.
Everything you have either belongs to you, or to your bank or other creditors.
Everything you have is described in Asset accounts. Everything your bank or
creditors has loaned to you is described in Liability accounts. Everything
you can call your own is summarized in Equity accounts. The sum of what you
OWN and what you OWE, therefore, equals the value of what you HAVE:
What You Have = What You OWE plus What You OWN.
Your books therefore BALANCE. Each side is equal. That is double-entry
bookkeeping in a nutshell, and the rest is just practice and experience. The
equation is called the Fundamental Equation of Accounting:
Assets = Liabilities + Equity.
For example, your Checking Account is an ASSET. You have money. But your
bank owns the money it lends you. If you take out a loan, the TRANSACTION is
a two-edged sword: You increase the value of your Checking Account, AND, you
increase the level of your debt. The difference in either account is exactly
the same. There is a CONVENTION that you DEBIT assets (record them in the
left column) and CREDIT liabilities (right column), that is:
Left = Right.
Left + Amount Loaned = Right + Amount Owed.
If you are familiar with algebra or computer programming, this might be a
useful insight: A Ledger ACCOUNT is like a VARIABLE. It can contain a value
or no value at all. The value it contains can be positive (LEFT column) or
negative (RIGHT column). And the account can have a name, independent of the
value in it. This parallel with algebra is very suggestive to historians and
it has been used to teach accounting at least since Beau Brummel invented
pants. But it gets in the way, too!
The modern (post-Renaissance) convention further states that when you tote it
all up, you get zip:
Assets - Liabilities - Equity = 0.
It required the invention of algebra to realize this fact. But buried in this
simple-looking formula is the ultra-modern insight that computers can
represent Credits as negative numbers and Debits as positive; thereafter, mere
addition automates everything! That's great for programmers, bad for people.
Assets + ( -Liabilities ) + ( -Equity ) = 0.
Unfortunately, bad design in accounting software all too often forces people
to think like computers. Instead of writing plain positive numbers in
traditional left and right columns -- the method used for centuries -- bad
human factors force you to think in and use negative numbers. And negative
numbers are a pointless, unnecessary distraction.
The algebraic interpretation is pervasive and correct. But it's also wrong.
With GL version 1.12, you don't have to add or subtract anything.
The reason you use this GL program (or any other) is so YOU DON'T HAVE TO
THINK ABOUT THE ARITHMETIC, period. Just record your transactions, following
the Debit (left column) and Credit (right column) rules by rote, and the rest
truly is automatic!
Visual Reminders of Rote Rules
------------------------------
The "rote rules", in GL version 1.12, are clearly indicated in your General
Journal. Every account you use is marked by a "+|-" or "-|+" reminder, to
indicate which columns you use to INCREASE or DECREASE an account's balance.
Asset and Expense accounts are marked "+|-", meaning that you put money into
your checking account (an Asset account) in the LEFT (debit) column, and you
increase the level of your expenditures the same way. (But notice that
increasing expenditures means decreasing income. Expense accounts are a
special case of the pattern for Liability, Revenue and Equity.)
Liability, Revenue and Equity accounts are marked "-|+", the exact opposite.
You take out a loan (Liability) in the RIGHT (credit) column, you pay off your
creditors in the LEFT (debit) column. You record dividend income (a Revenue
account) the same way. You record your capital investment (an Equity account)
in the RIGHT column, and you record your personal withdrawals from capital
(also an Equity account) in the LEFT column.
Double entry means that you DEBIT AND CREDIT every transaction, once to an
account in the left column, and once to another account in the right column.
If you receive dividend income, DEBIT your (Asset) Cash account and CREDIT
your (Revenue) Dividends account. See the General Journal documentation for
some other examples.
The Check Register function of GL version 1.12 handles the special case of
recording your checks and checking account deposits. The "+|-" reminders are
not shown there, because you do not have to decide for yourself which columns
you should use.
Revenue & Expense Accounts are Equity Accounts
----------------------------------------------
It's not obvious where the notion of profit & loss fits into the fundamental
equation of accounting. It's not obvious that profit is even relevant to some
kinds of accounting, such as home bookkeeping, or non-profit corporations, or
government agencies. A deficit or zero "profit" has special meaning in these
cases, but it's still "profit" -- Revenues less Expenses -- although you may
call it something else. In the case of home accounting, if your income
exceeds your expenses, the difference contributes to your total Net Worth.
Revenue and Expense accounts are the instrument you use to keep track.
This is worth emphasizing:
Revenue and Expense accounts are all a species of EQUITY
account. That is, a credit to an EXPENSE account has exactly
the same effect on your Balance Sheet as a credit (!) to a
REVENUE account.
Is that what you expected? If you understand that, you understand everything
there really is to know about double entry bookkeeping. Discussion follows!
The only difference between a Revenue and an Expense account is what you USE
it for, the kind of information that gets stored there. This is why we can
say that account numbers in the 600's, 700's, 800's and 900's are Expense
accounts (like 500's). To look at it another way, all th