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February 11, 2017

Do you really understand the language of business? Part II

The science of bookkeeping

“Double-entry bookkeeping was a hell of an invention.”
– Charles Munger

Not quite convinced? How about this:

“Few have heard of Fra Luca Pacioli, the inventor of double-entry bookkeeping; but he has probably had much more influence on human life than has Dante or Michelangelo.”
-Herbert J Muller

Wow! Good ol’ double-entry bookkeeping!

I say ‘good’ because there is nothing but good in double entry bookkeeping. And I say ‘old’ because it was invented all the way back in the 15th century. Yes, it has been around for more than half a millennium – unchanged and unchallenged!

(Note: I am going to repeat the word double entry bookkeeping so much today, so just to make it a bit less sickening, I will shorten it to ‘DEB’ in the rest of this article).

In my earlier column, I promised I would write next about the art and science of accounting. Let’s start with the science – DEB is nothing but pure science. But before I venture on any further, if you are are wondering what the difference between ‘bookkeeping’ and ‘accounting’ is, let me give you a simple formula which should be easy to remember:

Accounting = bookkeeping + some more

(to answer your yet unformed question, yes, the next few articles will focus on the “some more.”)

So what exactly is DEB? Bookkeeping simply means maintaining the financial records of the business. Double-entry means you record both aspects of a transaction – by debiting one aspect and crediting the other.

What do I mean by two aspects of a transaction?

Say, you bought a car and paid fully in cash. This transaction has two sides:

1. You got a car

2. You paid money

In DEB, you would record both these aspects like this:

Debit Car, Credit Cash

Now, let’s say you bought the car on credit instead. Then the two sides are:

1. You got a car 

2. You incurred a liability to be settled in the future. 

Here, DEB would record both the car and the liability like this:

Debit Car, Credit Liability

You get the general idea.

There have been other methods of bookkeeping (the equally uncreatively named ‘single-entry’), but these are not much used in practice and do not provide the comprehensive information that DEB does. Whether you use the 19th century journals or you account on the cloud, whether you use Oracle or SAP or Sage or Quickbooks or Xero or Tally or any other countless accounting software out there, each and every one of these is based on DEB. DEB can, thusly, be said to be the foundation of virtually every piece of financial information out there. 

Okay, so why do I call it a science? It is because there is a precise logic to DEB in terms of what to debit and what to credit, and you have to follow it correctly, otherwise you end up with pure nonsense. Think of how two molecules of hydrogen and one molecule of oxygen make water. It has to be that way; if it is any other way, you don’t get water, you get something else. DEB is kind of like that. You have to debit what you have to debit and you have to credit what you have to credit. If you do it the other way round or you debit/credit something else, you get a very different result. 

In my long career as an auditor, I have seen many things – not least how some bookkeepers muddled their bookkeeping and got some horribly botched results. Like that time when one poor chap had debited “expense” instead of “advance” for an amount paid as advance to supplier. The transaction was incorrectly recorded as an expense meant there was a real risk that the company management might forget about the existence of this advance – potentially resulting in a real loss of real money. (Too many “reals”? That was deliberate, just to bring home how really important all this is).

I close this article with an expansion of Charles Munger’s quote,

"Double-entry bookkeeping was a hell of an invention. And it's not 
that hard to understand...."

Well, he can say that, but I know for a fact that many people think otherwise. I suspect the general perception that accounting is boring has something to do with this, but hey, all that’s good is generally boring!! If you are one of those who struggle (or don’t care) to understand bookkeeping, know that you are not alone. Such apathy and ignorance are common enough and that’s why firms like ours are in business. Whether you are a small or large company and whether you are a start-up or well established, we are just a phone call or email away if you need any guidance, support or assistance with any aspects of accounting or bookkeeping. In fact, call us even if you are not sure what it is exactly that is bothering you. We are experts in diagnosis, detection, prevention and treatment of all your accounting and bookkeeping issues. We promise not to act elitist when we speak to you. We will step down to your level, and won’t show our innate arrogance and “know-it-all” attitude one bit! In fact, our modesty will blow your minds away – just give us a try.

Till the next one,

Cheers!

Nish 

www.nisheconsulting.com

This article is part of a series – for the previous article, go to Do you really understand the language of business?

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