Finance Basics. Stuart Warner

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       2.3 Know about doubleentry bookkeeping

      Accountants use an established system of recording financial transactions, called double entry bookkeeping. The globally used system has hardly changed since it was developed in 1494 by Renaissance scholar Luca Pacioli.

      Pacioli’s principle is that every transaction has a dual effect. For example, if you get paid for work, then the first effect is that you’ve earned income and the second effect is that you now have more money. If you go clothes shopping, the first effect is that you have more clothes. The second, more unfortunate effect, is that you have less money.

      case study Be careful not to confuse the words ‘debit’ and ‘credit’. For Brian and other accountants, a ‘debit’ represents an asset and a ‘credit’ a liability. A ‘debit’ will increase the value of an asset and a ‘credit’ will reduce its value. For example, a bank receipt, which increases cash (and hence is a business asset) is a debit. Similarly, a bank payment, which reduces cash, is a credit. This is the opposite way around for banks. For example: The Little Socks Company has $1,000 in the bank and therefore has an asset of $1,000 which is a ‘debit’ in The Little Socks accounts. The bank holds the $1,000 but owes it back to The Little Socks, as it is not the bank’s money. The bank has a liability to The Little Socks of $1,000 which is therefore a ‘credit’ in the bank’s accounts. The bank tells The Little Socks: “You are in credit for $1,000”.

      “Never call an accountant a credit to his profession; a good accountant is a debit to his profession”

       Sir Charles Lyell, British lawyer and geologist

      Likewise, when a business makes a purchase, it (i) incurs an expense and (ii) has less cash. Similarly, when it makes a cash sale it has (i) more income and (ii) more cash. The system is called double entry bookkeeping because every transaction is effectively recorded twice.