Answer by Peter Baskerville:
Why is the idea of debits and credits so difficult to grasp? It is clearly the most confusing concept to understand in accounting, which is why most students simply learn the ‘debit’ and ‘credit’ rules by heart and then apply them according to the rules. But I still think it is important to fully understand the concept if you are going to get the best out of your accounting knowledge and skills. Here’s why I think ‘debits’ and ‘credits’ is such a difficult concept to grasp and some explanations that should help you to better understand it:
- Confusion about the terms: The terms ‘debit’ and ‘credit’ have unique meanings in accounting and they have no relationship with any other meanings of the terms. The accounting terms ‘debit’ and ‘credit’ are always going to be difficult to grasp if you keep trying to relate them to other uses of these terms in everyday life.
- Confusion created from a long history: The concept of ‘debit’ and ‘credit’ originated over 500 years ago with the Venetian merchants. The first double-entry bookkeeping textbook was written in Latin by Franciscan friar Luca Pacioli (1445 – 1517) in his Summa and published in 1494. If you don’t understand that the terms ‘debit’ and credit’ originated in Latin as ‘debere’ and ‘credere’, then you wouldn’t realise that these terms mean (to owe) and (to entrust). See Luca Pacioli saw that external funders and owners entrust (credit) money to a business so it can acquire assets. But the business then in turn owes (debit) the value of these assets back to the funders. If you don’t understand the history of accounting then the concepts of ‘debit’ and ‘credit’ will be difficult to grasp. This animation and narrated story may help in this regard.
- Confusion about ‘+’ and ‘-‘: A review of history will also tell you that negative numbers were not a generally accepted mathematical concept in Europe when Luca Pacioli codified the double-entry bookkeeping system in 1494. So it was an incredibly innovative concept at the time of getting the books of a business to balance by using ‘debit’ and ‘credit’ rather than ‘+’ or ‘-‘, which must be very confusing to 21 century students today where the concept of negative in mathematics is so mainstream.
- Confusion about the role of business: The concept of ‘debit’ and ‘credit’ is built on a fundamental truth that a business is created by the owners for the owner’s benefit. So the value of all the assets (less the liabilities or debts that the business has incurred) are owed to the owners. This truth can be formulated into an equation of: Assets – Liabilities = Owners Equity or rearranged into what has become known as the accounting equation: Assets = Liabilities + Owners Equity. The role of ‘debits’ and ‘credits’ is to accurately maintain this fundamental truth, as represented by the accounting equation. If you didn’t understand this vital role of ‘debit’ and ‘credit’ then you wouldn’t understand why certain accounts are debited and others credited, nor would you understand why the treatment of a recorded transaction would change depending on what was needed to ensure that the balance in this equation is always maintained.
- Confusion about different treatments of the same transaction: Luca Pacioli’s double-entry bookkeeping system was designed so that the owners of the business could get a constantly updated report on the financial position and performance of their specific business. So financial transactions in the double-entry bookkeeping system are recorded from the perspective of the individual business. If you did not understand this principle then it would be difficult to understand why say a deposit to the bank account of a business is recorded as a debit in the Cash at Bank account of the business but recorded as a credit on the bank statement produced by the bank. See while Cash at Bank is an asset account in the double-entry bookkeeping system of the business, the bank must treat the deposit as money owed to another business and therefore records it as a liability in their double-entry bookkeeping system for their owners.
- Confusion about the application of ‘debits’ and ‘credits’: I remember asking questions of my teachers about the reason why ‘debits’ and ‘credits’ were applied in the way they were and always got the same response … because that’s the system. In accepting that answer I learned to apply ‘debits’ and credits’ long before I understood the why. I have explained previously much of the reasoning behind the ‘debit’ and ‘credit’ concept, with the final explanation being that ‘debits’ and ‘credits’ really represent the flow of economic resources that takes when a financial transaction occurs in the closed system that is the world of finance. See financial transactions cause economic values to flow from something to something else. We see this concept represented in the Latin meanings of the words ‘debere’ and ‘credere’, where economic value is entrusted ‘credere’ to a business which then creates an obligation on the business to owe ‘debere’ the equal amount of economic value back to the entrusters. Rather than simply apply the ‘debit’ and ‘credit’ rules, you can explain all financial transactions in terms of the first-principles of economic value flow: from (credit) to (debit). Here is the full story on how you could do that –
The truth is, you will be better off in your student years to just learn the rules of ‘debit’ and ‘credit’ and then apply them correctly. Still, if understanding ‘the why’ drives you to insanity as it has me, then make sure you follow my accounting answers on Quora or my blog (above) because I am determined to figure it all out before I shuffle off this mortal coil.