The mathematics of accounting is as easy as counting beans.
The mathematics of accounting is elementary. It's the principles behind accounting that create confusion. One of the most confusing accounting principles is the double-entry system. Every accounting transaction requires two accounts and two entries, a debit entry and a credit entry. Mastery of the knowledge of which account is debited and which account is credited is the key to unraveling the mystery of accounting.
The Chart of Accounts
Understanding debits and credits starts with the chart of accounts.
The accounting process starts with setting up a chart of accounts. This is the list of the business activities (accounts) that receive the debits and the credits. The list of accounts can be brief or very extensive, depending on the complexity of the company's operations. For example, the main accounts can be divided into five groups: asset accounts, liability accounts, revenue accounts, expense accounts and owner's equity accounts. Each account in the chart of accounts has two columns, a debit column on the left and a credit column on the right.
Location of Account Balances in the General Ledger
Asset and expense accounts have their account balances and show increases to the account balance on the debit side, the left column of the general ledger. Liability, revenue and owner's equity accounts have their account balances and show increases on the credit side, the right column of the general ledger.
The Double-Entry System
The most fundamental rule of double-entry accounting and bookkeeping is that each accounting entry must, in fact, be two entries. One account will receive a debit entry in the left column while another account receives a credit entry in the right column. Selection of the proper accounts for the correct debit and credit entries is critical for accurate record keeping.
For example, a company receives a shipment of raw material used in the manufacturing of a product. Two accounts are involved in the transaction: raw material inventory (an asset account) and accounts payable (a liability account). Raw material inventory will receive a debit in the amount of the invoice for the shipment to reflect an increase in inventory. Accounts payable will receive a credit in the same amount to reflect an increase in accounts payable. When the company pays the supplier for the raw material, cash, an asset account, will receive a credit to reflect a decrease in cash, while accounts payable will receive a debit to represent a corresponding decrease in accounts payable.
History of the Double-Entry System
Leonardo DaVinci's friend, Bartolomes Pacioli, is credited with being the first to come up with the double-entry system of bookkeeping. According to the legend, Pacioli is reputed to have used double-entry bookkeeping in helping DaVinci compute the quantity of bronze required for DaVinci's statute of Duke Lidovico Sforza of Milan.
Debits on the Left, Credits on the Right!
This is the mantra that every student learns in basic college accounting. Unfortunately, the simplicity of the mantra leads many students to the literal interpretation that all increases to an account are debits, while all decreases to an account are credits. It is more useful to remember which accounts show balances and increases to balances on the debit side of the general ledger, and which accounts show balances and increases to balances on the credit side of the general ledger. Decreases to debit balances will be credits, while decreases to credit balances will be debits.
