by Garrett Fisher
October 15, 2013
It doesn’t take a degree in accounting to realize that the profession can be utterly befuddling and mind-dumbing. The father of double-entry accounting, Luca Pacioli, wrote some drivel about the clarity provided a merchant when getting their accounting straight – something that elicited quite the laugh as, at the time of reading that statement, I was in the middle of dissecting one of the more forensic disasters of my career. Whether a frustrated businessperson, an entry-level accountant learning the ropes, or a seasoned finance veteran, I haven’t to date found anyone that has built a particular sane spatial reasoning system to translate the debit and credit methodology to something that consists of common sense. There are some very “special” people that can get their head around it and enjoy it simultaneously; yet, they lack the ability to translate that understanding to the average person. Even finance leaders tend to get annoyed and simply move up the ladder well past actual debit and credit gerrymandering.
Blame for confusion can be cast on the double-entry system. For every credit, there is a debit somewhere – and spatial attempts to equate this system to other known cognitive assumptions is where the trouble starts. For starters, there is the income statement and balance sheet – creating a matrix of entry types. These financial statements can be reworded as “what we earned and what we spent” for the income statement and “what we owe and what is owed to us” for the balance sheet (effectively, for practical purposes – we’re not getting into the capital side – though we can word that as “what investors paid us and what we paid investors”). When entries transcend these categories, it adds a dimension to the confusion that adds difficulty to previous assumptions.
For example, a person may get their head around income and expenses. Sales are credits and expenses debits. The common trend is to translate debits and credits as “good” or “bad” – as in, the perspective of the company. In the case of the income statement, credits are good and debits are bad. However, on the asset side of the balance sheet, it gets a little more confusing. Debits can be stated as “good” as they are the creation of a receivable – money owed to the company. However, is the creation of the receivable good (debit) or receipt of cash in payment of the receivable (credit)? But wait – the “bad” credit is also a “good” debit increasing cash. Clearly, the good/bad system doesn’t work so hot in this case as it’s a matter of perspective. On the equity side of the balance sheet, there is a similar problem – where one can ask: “Is receipt of a customer investment “good” or payment of profits via a dividend a better outcome?” In those cases, investment funds are a credit and distributions a debit. Clearly, using a “good” and “bad” system requires 4 different subsets of transaction type and it is subjective as to what is good and what is bad. What was hoped to be simple now got complicated.
In lieu of “good” and “bad”, equating debits and credits to integer number systems is another ploy. Namely, that one is negative and one is positive. Much like our battle of good vs. bad, that which is negative and positive compared to a debit and credit differs. In the case of the income statement, credits are positive and debits are negative. In the case of assets, debits are positive and credits negative. In the case of liabilities and equity, credits are positive and debits negative. Again, that which is supposed to be simple is complicated.
What makes matters worse is that most professionals start somewhere at the bottom of the accounting food chain. If an entry-level professional is doing clerical or basic tasks, they are not given comprehensive entries. AR or AP clerks function in one limited perspective and develop their debit and credit assumptions based on that. Once new dimensions are added, whatever coping mechanism they have developed doesn’t work.
For those familiar with software development, what I am about to say makes easy sense. Debits and credits are variables – placeholders, so to speak. Debits and credits carry balances through the accounting ledger resulting in financial statements that are both labeled and in positive and negative denomination. Namely, a balance sheet and income statement are not presented in debits or credits – they are presented in positives and negatives. As a placeholder, one cannot apply a permanent label at all to debits and credits. Rather, if they can understand what the debit and credit is doing to the standard numeric financial presentation, then things make sense. Understanding that the mechanics of accounting ledgers differ from the final presentation begins to present a key as to why the whole system can be confusing for anyone but the strangest of humans.