"Every day at 2.00 in the afternoon, you empty the cash register, except for $50 in mixed notes and coins, count the remainder, and go to the bank to credit the account before the bank closes at 3.30", the shop keeper told his new assistant. "It's 2.00 now, so get started, I'll look after any customers. Take the cash drawer into the back-shop, bring it back with $50 inside as soon as possible and then go back to count the remainder. You'll find a bank bag on the table. It's got a strap to secure it to your wrist so nobody can grab it from your hands. When you get back, you can make the necessary entry in the ledger. It's debit bank and credit sales".
"It can't be debit bank, you've just told me that I'll be crediting the account when I make the lodgement," the new recruit replied, a little surprised that he was being trusted with cash on his first day.
"Don't ask me; ask our over-paid accountant, that's what he told me to do. I was surprised too," the boss said. "I'm just a humble shop owner. I don't need to know the ins and outs of double-entry bookkeeping."
The honest young employee performed his duties, and at 5.00 p.m. he went home scratching his head as to why he had been asked to debit the bank account in the ledger, when, surely, the entry should have been a credit. Arriving home, he even checked his own bank statements and, although he had to go back a long way to find his last lodgement, there it was, clearly in the column headed "credits".
"The over-paid accountant's balmy," he thought to himself.
Whether the accountant was over-paid is possibly a debatable point, but he certainly wasn't balmy. If an enterprise has cash in the bank it is an asset. If it has an overdraft it is a liability. Assets have debit balances, while liabilities have credit balances. So the lodgement of the takings from 2 p.m. on one day to 2 p.m. on the next has to debit the cash at bank in the enterprise's records. The lodgment will have either increased a debit balance or reduced a credit balance. Both of these results are achieved by a debit entry.
Why then, does the bank tell you that you are crediting your account when you make a lodgment?
Simply, it's looking at the transaction from its own point of view, not that of the shop owner. If the enterprise has cash in the bank, the bank owes that money back to the enterprise. Therefore the shop is a creditor of the bank, a liability of the bank. So the balance in the bank's records must be a credit. If the enterprise has an overdraft, the bank is owed money so, in this case the shop is a debtor of the bank, an asset of the bank. So, in this case the balance in the bank's records must be a debit. The lodgment would have either increased the bank's liability or decreased its asset. Both outcomes are achieved by a credit entry in the bank's records. That is why a bank says that a lodgment is a credit, while the enterprise would debit it's cash at bank account in its ledger to record the same transaction. Similarly a payment is credited to the cash at bank account in an enterprise's ledger, while the bank statement will indicate that it is a debit.
This phenomenon is not restricted to banking transactions. Buyers debit purchases while sellers credit sales. Renters debit rent paid, while landlords credit rent received. Enterprises debit accounting fees, while accountants credit fees earned. And so the list goes on. When more than one entity is involved,double-entry becomes quadruple entry, and each entity treats the entry in the opposite manner.
Phil Ramage CA (Scot) CA (Aust)
For more information and, if needed, assistance, go to: http://www.bookkeeping-theeasyway.com
(C) 2011 Philip Ramage All rights reserved
Wednesday, 26 January 2011
Tuesday, 4 January 2011
Accounting Problems and Solutions- Why We Still Need To Understand Double-Entry bookkeeping
"Why do we need to worry about the ins and outs, and the whys and wherefores of double-entry bookkeeping, the computer takes care of all that boring stuff", I heard a junior colleague of mine ask recently.
"Goodness me, look how short-sighted you are", I replied.
True, the computer program should be able to take care of the majority of day-to-day routine transactions, but situations frequently arise when anyone in an organisation, of whatever size, from a financial director to a junior data-input clerk, may require to show they have, at least, a basic understanding of the principles of double-entry bookkeeping; a system that evolved in Italy, late in the 15th century and which is still the basis of all accounting and bookkeeping software available today, from the most simple, to the most sophisticated.
Here are a few reasons why:
* Not every enterprise has a computer. Many small operations try to make do either without regular record keeping, or make a mess of trying to maintain a manual system. Either of these scenarios can lead to:
I. Huge accountancy bills at the end of the Financial Year
II. Missing out on the opportunity of being able to maximise ones profitability and, just as importantly, enjoy a positive cash flow, by analysing the data flowing from a properly maintained system.
It is still perfectly acceptable for any small business to keep a manual set of books. However the most important thing is...If you are going to do it, do it right. That means that every successful small businessman or woman must have a basic knowledge of double-entry bookkeeping.
* Any person who sets-up a computerised system must have an extremely good knowledge of double-entry bookkeeping. Accounting errors made at this early stage, can, and will, lead to disastrous outcomes later on; for example:
I. Classifying an asset account as a liability account
II. Mucking up the input of opening balances by not knowing which accounts should start with a debit balance and which should start with a credit balance
III. Not ensuring that subsidiary ledgers balance with the main ledger
Examples of the effects of these errors could be:
I. Losing control of debtors
II. Losing control of creditors
III. Getting the computer to produce inaccurate reports, which, because they were computer generated, everybody from the managing director down would assume to be the gospel truth.
* Senior accountants must have a knowledge of "what should be where" to enable him or her to correctly analyse computer output, before preparing reports for the management. Some specific circumstances are:
I. Being able to consolidate reports of individual parts of the business into a single report reflecting the performance of the enterprise as a whole
II. Being able to produce Financial Accounts at the end of the Financial Year, that actually "balance".
III. Being able to confidently discuss matters of concern with auditors, and, if necessary, be able to support the enterprise's position in any dispute with auditors
* Junior accountants must have the knowledge to be able to input journal entries correctly to, for example:
I. Correct obvious posting errors
II. Charge Depreciation
III. Make, and possibly reverse accruals
IV. Enter and reverse prepayments.
The list could go on forever.
* Finally computer operators would be able to do their job much more effectively and accurately if they had an understanding of what the computer was doing "behind the scenes", rather than blindly following a manual.
These are just some of the reasons why, even in today's technological society, a knowledge of the concepts of double-entry bookkeeping is as important to all people who work in the field of finance as it ever was before the advent of computers.
To sum up, the conception that computerisation has spelled the beginning of the end of the art of double-entry bookkeeping is a misconception. Do you agree?
About the Author (Plain Text)
Phil Ramage CA (Scot) CA (Aust)
For more information and, if needed, assistance, go to: http://www.bookkeeping-theeasyway.com
(C) 2011 Philip Ramage All rights reserved
"Goodness me, look how short-sighted you are", I replied.
True, the computer program should be able to take care of the majority of day-to-day routine transactions, but situations frequently arise when anyone in an organisation, of whatever size, from a financial director to a junior data-input clerk, may require to show they have, at least, a basic understanding of the principles of double-entry bookkeeping; a system that evolved in Italy, late in the 15th century and which is still the basis of all accounting and bookkeeping software available today, from the most simple, to the most sophisticated.
Here are a few reasons why:
* Not every enterprise has a computer. Many small operations try to make do either without regular record keeping, or make a mess of trying to maintain a manual system. Either of these scenarios can lead to:
I. Huge accountancy bills at the end of the Financial Year
II. Missing out on the opportunity of being able to maximise ones profitability and, just as importantly, enjoy a positive cash flow, by analysing the data flowing from a properly maintained system.
It is still perfectly acceptable for any small business to keep a manual set of books. However the most important thing is...If you are going to do it, do it right. That means that every successful small businessman or woman must have a basic knowledge of double-entry bookkeeping.
* Any person who sets-up a computerised system must have an extremely good knowledge of double-entry bookkeeping. Accounting errors made at this early stage, can, and will, lead to disastrous outcomes later on; for example:
I. Classifying an asset account as a liability account
II. Mucking up the input of opening balances by not knowing which accounts should start with a debit balance and which should start with a credit balance
III. Not ensuring that subsidiary ledgers balance with the main ledger
Examples of the effects of these errors could be:
I. Losing control of debtors
II. Losing control of creditors
III. Getting the computer to produce inaccurate reports, which, because they were computer generated, everybody from the managing director down would assume to be the gospel truth.
* Senior accountants must have a knowledge of "what should be where" to enable him or her to correctly analyse computer output, before preparing reports for the management. Some specific circumstances are:
I. Being able to consolidate reports of individual parts of the business into a single report reflecting the performance of the enterprise as a whole
II. Being able to produce Financial Accounts at the end of the Financial Year, that actually "balance".
III. Being able to confidently discuss matters of concern with auditors, and, if necessary, be able to support the enterprise's position in any dispute with auditors
* Junior accountants must have the knowledge to be able to input journal entries correctly to, for example:
I. Correct obvious posting errors
II. Charge Depreciation
III. Make, and possibly reverse accruals
IV. Enter and reverse prepayments.
The list could go on forever.
* Finally computer operators would be able to do their job much more effectively and accurately if they had an understanding of what the computer was doing "behind the scenes", rather than blindly following a manual.
These are just some of the reasons why, even in today's technological society, a knowledge of the concepts of double-entry bookkeeping is as important to all people who work in the field of finance as it ever was before the advent of computers.
To sum up, the conception that computerisation has spelled the beginning of the end of the art of double-entry bookkeeping is a misconception. Do you agree?
About the Author (Plain Text)
Phil Ramage CA (Scot) CA (Aust)
For more information and, if needed, assistance, go to: http://www.bookkeeping-theeasyway.com
(C) 2011 Philip Ramage All rights reserved
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