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