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Understanding debits and credits

Management accountant and Great British Bake Off 2020 star Makbul Patel unravels the mysteries of debits and credits.

15th Feb 2021
Principle Accountant Bolton at Home
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Bookkeeping
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The first time I was exposed to debits and credits was during my time studying accountancy at university.

Everyone had Frank Wood thrust in their direction; that was the basis of my studies. Although there were other modules, pure accountancy was all about the debits and credits.

However, after graduating and eventually working in a professional capacity, debits and credits lost their meaning. As long as your journals balanced, there was no need to get flustered by anything else.

Fast forward a few years, and harbouring more than a mild boredom with accountancy, I decided to try my hand at teaching it. First, I enrolled at night school. After about two years I received my teaching qualification. Before long I was teaching AAT and bookkeeping in the evening. Many of the students I taught were very new to accountancy.

One of the myths I had to fight with the new students lay in the concept of debit and credit. The students invariably thought a ‘credit’ was adding value and a ‘debit’ was reducing value. Oh dear. What a challenge that was.

However, most students understood that the bank statement was where they would come across debits and credits day to day. Put money into your bank account - credit. Take money out - debit.

Explaining that the bank statement is your T account on someone else’s ledger was a different story. Barely anyone believed me, and I’m sure there are a few ex-students who still think I am stupid. Maybe I am.

I would even push my neck out and say that there are many accountants working in finance who probably still struggle with the concept of debits and credits.

Fast forward to the near-present - whilst making a steamed ginger pudding with the help of my undergraduate daughter, she made the mistake of discussing her bank statement and a little lightbulb lit up inside me. I went into auto-mode trying to define debits and credits (if ever regret filled my daughter’s life, it was now).

Being a management accountant, one of my key roles is to present figures to non-accountants; after all, the clue is in the title.

I have sat in hundreds of meetings and presentations where finance people talk to these non-accountants. 30 seconds in, eyes would glaze over and a frothy mess would drool out of mouths. Engaging the public in all things finance is challenging. You should see how I can empty an office of surveyors when I go to them for some capital spend information!

However, I do have one success story. I found myself in the unusual setting of the Bake Off auditions, where about 12 of us were corralled into a big studio kitchen in London (c’mon, I’ve been on the Bake Off! Forgive me for squashing your face onto my window of vanity). Makbul Patel

The potential competitor sat next to me told me she was a nurse. Upon informing her that I was an accountant, I could tell immediately the glazing of the eyes and frothing at the mouth was starting.

So in order to bring the conversation back to life, I said that the key to accountancy is to treat all the components as energy. 

Cast your mind back to your schoolday science classes and you might recall that energy cannot be created nor destroyed. Electricity going into a television set comes out as light and sound, but the (electrical) energy isn’t destroyed. It has been transformed into light and sound. The net quantity of energy remains the same.

The sun shining on solar panels converts solar energy into electricity. Fuel energy in a car converts into kinetic energy, heat energy and friction. The net effect on energy is zero.

Hang on - isn’t this the same concept as value within accountancy?

Thus I explained it as such to the nurse in the Bake Off audition room who had the misfortune of making eye contact with me.

If you take out £100 from your bank, the account value has gone down by £100 but the cash in your pocket has gone up £100. If you then bought a chair for £100, the value of furniture as an asset has gone up by £100 and the cash in your pocket has gone down by £100. Value has shifted from one place to another, but it has essentially remained the same.

If that chair is then smashed into little pieces, £100 has shifted from furniture into scrap but the value still remains £100. Value cannot be created nor destroyed.

How I swelled with a sense of achievement that I had explained accountancy to a nurse.

There was suddenly a chorus of screams in the audition room - it was the nurse, she was threatening to jump out of a window! Okay, there might be a time and a place to discuss accountancy and a Bake Off audition is probably not the ideal moment... I think I ruined her chances of being selected.

Replies (12)

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By Homeworker
17th Feb 2021 10:50

I remember vividly struggling with this when I was early in my career and first tried using Sage to record bank transactions for a client. I entered a whole month's transactions the wrong way round and had to journal out and re-enter every single one. I have never used Sage since!
Even some of the more user friendly packages do not make it easy sometimes to work out which is the debit and which the credit, especially with journals and I often find myself having to go back and reverse entries.
Oh, and I used to work in a bank in the seventies!

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By Justin Bryant
17th Feb 2021 11:42

Debits & credits is an example of something simple made unnecessarily complicated. You could just as easily use + & -.

I could teach someone basic P&L, B/S and debit & credit accounting in one hour I reckon, whereas an accounting college will take around a week to do that by bad teaching.

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Replying to Justin Bryant:
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By Paul Crowley
17th Feb 2021 19:25

My spreadsheet version of ETB has left headed + and right headed- on all columns for the reason in your first line.
People find + and- easier to understand.

BANKS caused a problem that will never go away

Back in articles, one person managed the entire ETB to be every entry on the wrong side, but got the right result
His Dad was a bank manager

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By Paul Crowley
17th Feb 2021 19:17

'if that chair is then smashed into little pieces, £100 has shifted from furniture into scrap but the value still remains £100. Value cannot be created nor destroyed.'

Disagree
Try selling the firewood that was the chair

Is depreciation really anti-matter?

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Replying to Paul Crowley:
Makbul Patel
By Makbul Patel
19th Feb 2021 09:15

However, we are not talking about NRV here. Even if the chair was sold as firewood, a fixed amount still goes to depreciation/loss. The value is still floating about somewhere. If the chair was stolen, the losses account goes up by £100. The value of the chair remains in the accounts.

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By New To Accountancy
17th Feb 2021 21:30

I enjoyed reading this.
Not long ago, one of my husband's friends asked me to tell him about what I do and a bit of background. My eyes lit up, and I didn't know where to start, so I began with Luca Pacioli and how in England the 'pipe roll' is the oldest surviving accounting record which contained taxes due to the King of England from 1130 to 1830, then (I was about talk about debits and credits being my 'I can do this' moment), but then ..... they all laughed - I fell for it!
I should have known when their eyes did not glaze over; more fool me!

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By tom123
18th Feb 2021 08:12

I couldn't quite get journals at uni.

Don't get me started on

"The sales day book has been under cast"

Once working it made sense.

Mind you, I have yet to do an internal rate of return calc or capital asset pricing model.

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Replying to tom123:
Hallerud at Easter
By DJKL
22nd Feb 2021 21:40

The one that threw me initially was purchase ledgers and sales ledgers. Create an invoice for Y Ltd, DR SLCA, CR Sales, but hold on you need to post it to the Y Ltd ledger card as a debit, so that's two debits, one to Y Ltd's ledger card and one to the SLCA, but only one credit, where's the other credit, what's happened, you told me every debit has a credit but this has a credit and two debits, panic, I do not understand.........

Double entry is a bit like learning to drive a car, one moment you are all over the place, stalling everywhere, the next you do not even really need to think about what you are doing with the debits and credits or, for that matter, with your feet.

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By raybackler
19th Feb 2021 10:46

I thought all you needed to know was debits nearest the window and credits nearest the door?

I too have had that problem of explaining away the bank statement. Happily with bank feeds and the subsequent posting, most people don't now they are posting debits and credits or that it is double entry bookkeeping underneath the bonnet.

This is OK until something goes wrong and then you do need to know what is beneath that bonnet!

All accounting systems add up to Zero, a point well understood by Xero, whose name I don't think arose by accident.

An amusing article, thanks for posting.

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By paddy55
19th Feb 2021 12:10

I have written an article on understanding double-entry bookkeeping. I hope somebody finds it of interest.
http://members.iinet.net.au/~patrick6/kiss38.html

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By ArianBloodwood
23rd Feb 2021 11:07

Thanks Makbul - very helpful!

I've always been intrigued by how the pre-mediaeval ppl did their bookkeeping prior to the Medicis inventing the Profit & Loss Report: all entries must have been posted direct to the Balance Sheet, and the Balance Sheet was one's only report.

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By Tipton235
25th Feb 2021 03:43

A sheet which lists the debits in the left column and credits in the right column. It balances the total debits and credit costs incurred to a company.

https://www.facetimeapp.net/

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