Saturday, May 14, 2011

Oh Wow! Double Entry Bookkeeping 101 (with Franz Hoermann!)

(Lovingly translated [with notes and explanatory emphases] into English by me. Sorry, this isn't exciting, but it is important to understand this stuff as part of transcending it. Personally, I find accountancy cruelly counter-intuitive. If I've made any jargon-errors (very possible), please flag them for me. A quick note; a “debit” is an “asset” and a “credit” is a “liability.”)

“There are many reasons why double entry bookkeeping is called “double.” One is visible in the fact that each sum of money is recorded twice, once as the value of an actual object and once as a representation of its origin. These entries have been written down since the Middle Ages as doubled “billing points,” called accounts, on the left side “Debit,” with “Credit” on the right. Should a businessman found a company with 1000 Euro in its account, it would be recorded like this:

The debit side of the Cash Account lists each asset which is physically present and assessable, here it's simple bank notes. The Cash Account is an active balance sheet account, which means its end result (accounting balance) is displayed under the left column (active side). Active balance sheet accounts show assessable assets (e.g. cash, stock like goods and raw materials, machines, buildings, land, but also patents, licenses and other rights), and represent their money value. Thus the value of the debit side increases, while it decreases on the credit side. Should 200 Euro be taken from cash assets [a decrease], it must be recorded on the credit side of the Cash Account, and is therefore booked under Credit.

With the Proprietary Account on the other hand, we are dealing with a passive balance sheet account. That is, its end result is displayed under the right column (passive side). These accounts list the assets' origins as 'legal initiations.' The so-called “debts” recorded here account for credit capital. Assets 'given' to the company by its owner are hence recorded under the Proprietary Account, since they represent the owner's legal claims.

On the other hand, money borrowed by the owner from a bank would indeed be listed on the left, under Debit in the Cash Account, but recorded under Credit in the bank liabilities account [an entry type under Proprietary Account?]. These numbers denote, then, that a liability (debt) against a bank exists to such and such a degree. So, were we to produce a balance of our company after the deposit of 1000 Euro, it would look like this:

Since the amount is recorded doubled, the Balance balances (assets tally exactly with liabilities).

And now we can discern the historical thinking behind double entry bookkeeping: it was an antique system for the safe recording and management of data. The doubled entering and totaling was supposed to ensure that no omission or human error corrupted the information, but in the days of electronic databases we need no longer be reliant on such primitive security systems. The money amount itself finds itself only on the asset side (of the Cash Account). The liability side only tells us to whom the legal claims on the assets would accrue – here the owner. So, if the owner buys a machine for, say, 800 Euro, this yields the following booking: Machine Account (Credit) on the Cash Account: 800 Euro. In the accounts:

Because the machine was purchased for cash and the cash position thereby decreased by the sale amount (here 800 Euro), the booking is effected on the credit side of the Cash Account as an inventory decrease, whereas the Machine Account records it under Debit as an inventory increase. But this yields no changes on the asset side of the balance sheet, since both the cash – which thereafter belongs not to the businessman but the seller of the machine – and also the machine it bought, both legally belong to the businessman, thus the Proprietary Account remains at 1000 Euro. [This is poorly written in the German I feel. The cash that belongs to the machine salesman is exactly not the remaining cash that belongs to the business owner. But in the weird world of accounting, who knows!] Since in this case only entries on the asset side are affected (the Machine Account increases whereas the Cash Account decreases, we call this an “asset swap.”

After the cash purchase the balance sheet looks like this:

So we can see that whatever happens to the real assets is recorded only on the asset side. The liability side is only affected when profits or losses are registered, or when changes in legal relationships occur.”

(In following weeks I'll translate subsequent sections that, together with this 'basics' passage, should demonstrate how double entry bookkeeping, value, banking and 'free' market economics operate together, as a cohesive system, to perpetuate the hierarchically organized fleecing of the poor by the rich.)


Sam Smith said...

Such an interesting post. Great info, i believe the people at Bookkeeper Melbourne so a great job with many of the things you have mentioned.

Toby said...

Thanks Sam (I think), but the link looks like a straight-up accountancy service:

"The most professional bookkeeping services Melbourne can provide!"

That's not why I wrote this post. And I'm not here to advertise anything. Go seek your food elsewhere.

Shawn Thuris said...

Thanks for translating this. I've been wrestling with the meaning implied by the double-entry system and this helps a bit. I understand the T-accounts and the fact that liabilities and owners' equity need to go on the opposite side from assets so that everything will balance...but to understand what entity owns what and who owes what to whom is a bit trickier. I saw the advice elsewhere to think of each sub-account as a person engaging in give and take, in order to see the system more intuitively.

Venita Arguelles said...

Great breakdown here. Shows that there are dimensions in this bookkeeping business that needs to be analyzed and assessed for this to be done right. Splendid job here!

Venita @ A Reliable Bookkeeping Services

Ram said...

Valuable info here. I like the way of writing style in this article. I clearly understand some new info about double entry.

Accountingweb article