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Debits & Credits. Why oh why do they exist?

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Here is why.

By an ancient accountant


1. Why this subject?


Folk always ask “why?”


2. Who is this for?


Everyone.


3. Where? Country:


Anywhere English is understood.


4. What you need to know:


Nothing.


MOTIVATION


It is a challenge to explain and keep it simple.

Understanding debits and credits typically takes a university student novice two weeks full time, in my experience.


INTRODUCTION OF CONCEPTS & ASSUMPTIONS


The problem is how to keep track of both who put money in and what it was spent on: at the same time, in the same moment, forever.


Concepts

Debits and Credits as invented 1494 - hundreds of years ago, long before modern computers.

https://en.wikipedia.org/wiki/Debits_and_credits 


Assumptions


None.

.


Debits & Credits - a faerie story - the reason why.


Once upon a time several merchants gathered together to discuss a business venture. 


Having agreed how the venture would operate and how the spoils would be shared out if there were any, each put an amount of money in to a central pot on the table. 


The money was counted and the total written on the outside of the pot, with a note of how much was from each of them making up this total put in the pot with the money.


In order for the business to commence it was necessary to remove money from the pot to spend it. The problem was that this would change the total on the pot as well as interfering with the measure of how much had been put in by each of the three of them. 


What to do? 


All the money was removed from the first pot in exchange for a note saying where it had gone,  and put in to a second pot from which it could be spent, without altering the details recorded on the first pot or the notes within it.


Pot One listed who put in how much and the grand total credited to the business - plus a note where the cash had been put - i.e. in Pot 2.


Pot Two was now going to be spent on business matters; for example some fresh coffee was needed and some stationery to keep writing notes which up to now were written on serviettes found on the table, with a borrowed pencil.


At this point in the proceedings, the grand total on each pot was exactly the same, with the advantage that Pot 2’s label can now be updated with notes about what its contents would be spent on without interfering with who put how much in to the business in the shares “Pot 1”. Notice that neither pot is negative or "a minus".


Each time some money was removed from  Pot 2 a note was put in the pot to say what it had been spent on.


In this way Pots 1 and 2 by definition will always have the same grand total of "noted amounts" and money.


Sometimes the money was not spent in that instant, but was carried away by someone to be spent on different things or even services. In this case the note put in the pot simply stated how much was taken out and who it was given to/by who, somewhat like an I.O.U. 


When the person returned having spent the money, or some of it, they removed the “I.O.U.” note and replaced it with a note for each item on which they had spent some money, and if any were left a fresh “I.O.U.” note giving this amount left, or returning the excess cash to the pot.


At any given moment in time, the grand total of money and notes in each pot is always exactly the same. 


And so it was that the two full pots became the beginning of everything and have remained always in balance for ever after.


THE END




Sometime later:


To avoid confusion each pot was given a name.


Pot One was named SHARES pot, because it listed who put in how much and the grand total credited to the business - plus a note where the cash had been put. 


Pot two was named CASH pot, because it was cash, and was now going to be spent on business matters; for example some fresh coffee was needed and some stationery to keep writing notes which up to now were written on serviettes found on the table, with a borrowed pencil.


Allocated to Excel because that's where they are used every day and always.






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Ok, the burning question is always "but why are they the other way round on my bank statements?" The answer is that your bank statement is a copy of the entries in your bank's books, NOT YOURS. To your bank your money is a liability not an asset.

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