Basic Accounting Concepts 2 Debits and Credits

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Most people dont nd the math of Accounting as dicult as understanding the concepts of accounting, and for
many there is no more dicult concept to grasp than that of Debits and Credits. Now the concept of Debits and
Credits is actually more than 500 years old, being used extensively by the Venetian merchants of Italy in the 15th
century Renaissance period. The concepts were rst documented in Latin in the 1400s and were later
translated into English in the 16th century. Is it any wonder then, with the passage 500 years, that we may have
become a little confused about the original meaning and concepts, particularly with the English language
adopting new legal and everyday meanings for these age old words. So it may be benecial then, as we try to
understand the concept of Debits and Credits, to go back to where it all begun but rst some background.

Basic accounting concepts for bookkeeping students

This training session is targeted at students who have a desire to learn more about bookkeeping. While
specically developed for students other people interested in understanding more fully the accounting concepts,
may also nd this training session benecial.
Prior to commencing this training session, it is recommended that you rst complete the Basic Accounting
Concepts 1 Denitions.
This training session assumes that you know a little about bookkeeping but that you realise to progress in your
work application or your learning, you need to understand more fully the concept of Debits and Credits. So, this
session seeks to deliver training on the concept of Debits and Credits, from the student bookkeepers point of
view.

Keywords
Credits, debits, rm, accounts, accounting concepts, bookkeeping, nancial transaction, accounting system,
Luca Pacioli, account group, double entry bookkeeping, duality of nancial transactions.

Learning outcomes
At the completion of this training session, you will be able to answer the following focus questions:
1. What is the origin of Debits and Credits?
2. Why was it called Debit and Credit?
3. What are the underpinning concepts for Debits and Credits?
4. How would they have applied Credits and Debits in the 1400s?
5. Is there another way to look at applying Debits and Credits?

Introduction Debits and Credits

The dictionary denes Debits and Credits, for the bookkeeping system, as Debits being those entries recorded
on the left side and Credits being those entries recorded on the right side. Now some people are comfortable
with this denition and after learning all the other rules and axioms of bookkeeping, go on to become very good
bookkeepers.

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However, there are others that want to know more about this basic accounting concept of Debits and Credits so
that they can apply them in a more meaningful way. If you are in the latter group, then this Knol is for you. It will
also make it clear that while rules must be learnt, at some stage the reason for them must be made clear; if this
is not done it has little educative value (Russel, B. (1924) Economic Individualism. Cambridge. On Education)
Before proceeding, it would be very useful for both the rule-learning and concept-understanding bookkeeping
students to learn o by heart the table given below and to also have a solid understanding of the denition of
each account group used in the bookkeeping/accounting process.
Note: One thing that is very clear is that the terms debit and credit, as used in bookkeeping, has its own special
meaning and it should not be confused with any other meaning of the term. (i.e. Debt as in owing money to
someone or Credit as in having time to pay for the purchase of goods are not denitions of the Accounting Debit
and Credit) Also, the accounting meaning of a term may have a dierent application to the legal meaning within
the same country.

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Under the Table 1 approach you would ask the following questions
when ever required to record a nancial transaction in the rms
accounts.
1. What accounts are involved? (There must be a
minimum of 2)
2. What account group do they each belong?
(They must belong to one of the ve)
3. Has the nancial transaction increased or
decreased the $ amounts in this account?
4. Apply the table logic.
5. Make sure that the total amount $ of the debits =
the total $ amount of the credits.
Table 2 Denitions of Basic Accounting Concepts

Whose Perspective?
One credit that worries most newcomers to accounting, is the one that appears on their bank statement. See
they have just learnt that cash at bank is an asset and according to Table 1 when you increase an asset you
debit it so how come the credit balance in my bank account goes up when I deposit money they ask.

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Well the answer is one that is fundamental to the accounting system. Each rm records nancial transactions
from their own perspective. So, think about the banks perspective for a moment how do they view the
money you have just deposited? Whose money is it? Thats right it is yours! So your deposit is treated, from
the banks perspective, as a liability (money owed by the bank to others). When you deposit money into your
account, THEIR liability increases which is why (using Table 1) they credit your account.

Session Debits and Credits

PART 1 What is the origin of Debits and Credits?

In more primitive trading times, bookkeeping was not such a big issue because the person who manufactured or
produced the goods was usually the person selling or trading the goods in the market place. However, the
Renaissance period saw a huge increase in both trade and banking systems brought about by the Roman-built
transport systems and the growth of more sophisticated societies like those in Italy (particularly Venice). So, the
merchants of Venice in the 1400s, developed an accounting system to accurately record these more complex
nancial dealings that were prevalent of the time.
Now a Franciscan friar and mathematician from that era, Luca Pacioli (14461517), is widely regarded to be
the Father of Accounting because he was the rst to codify and publish this accounting system in his book titled
, The Collected Knowledge of Arithmetic, Geometry, Proportion and Proportionality (translated). The book was
published in 1494 (about the time that Columbus discovered America) and it was one of the earliest books
published on the Gutenberg press.
Luca makes no claims about inventing the system but he does present it in a way that others can easily
understand it. His motive for recording the bookkeeping system, that was used by the Venetian merchants
during the Italian Renaissance period, was to help Guidobaldo, the Duke of Urbino, in the management of his
nancial aairs.
This documented system, described in only one section of the ve-section book, has become known as the
double-entry accounting system. The 36 short chapters on the accounting system contained in the book,
became the only accounting text-book for the next hundred years and its principles have been continuously
followed by accountants right up to today.
Interestingly, Luca Pacioli was actually a colleague of Leonardo da Vinci and it was Leonardo who helped him
illustrate his second most important manuscript De Divina Proportione (Of Divine Proportions).
This fact was mentioned by the author and Leonardo Da Vinci mentions Pacioli many times in his notes.
Opposite is a drawing of the Polyhedra which was one of the illustrations by Leonardo in Lucas book. Other

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interesting facts are uncovered by Marcino Guerrero in his Knol Pcaioli and Da Vinci#
Most of Lucas work still underpins the accounting system we use
today. Those basic accounting concepts from his book in 1494 that
are still practiced today include;
The accounting cycle
The use of journals and ledgers
Debits equalled credits double entry bookkeeping
The account groups of assets (including receivables
and inventories), liabilities, capital, income, and
expenses
Year-end closing entries
The trial balance, which he believed should be used to
prove a balanced ledger.
Summary
In Part 1, we learned about the 500 years history of Debit and
Credits and the signicant contribution made to the world of
accounting by the Franciscan friar and mathematician Luca Pacioli
with his double entry bookkeeping system.

PART 2 Why was it called Debit and Credit?

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Now remember, Luca was more a mathematician

than an accountant, so his mind would have been
trained to look for the key principles, concepts and
symmetry that underpinned the Venetian merchants
nancial recording system.
Key concepts he would have identied were (1) that
in the accounting world, the business (or rm) was an
entity in its own right and that that entity was separate
and distinct from the owners. Another principle he
would have seen is that (2) the nancial world is a
closed system. That is, money just doesnt just
materialise form nowhere. If money is received by
someone it must have been given by someone else
and vice versa.
This closed system of giving and receiving would
have led him to see the concept of duality in nancial
transactions relating to a rm. For example, when an
amount of money is entrusted by someone to a
separate and distinct rm, then that rm would now
have an obligation and owe that person the same
amount of money in return.
Using his native Latin, Luca named the act of
entrusting Credre (which means to entrust) and
the corresponding obligation on the rm Debere
(which means to owe). So, from the point of view of
the rm, he could see that this principle of duality held
true for every nancial transaction entered into by the
rm. For him, it was not just a formula but an aspect
of existence where one side could not exist without
the other. In a closed system, every Debere must
have a corresponding Credre and vice versa. In
other words, Debere and Credre were two sides of
the same coin. (In nance when someone entrusts
money then someone else ends up owing it).
Luca would also have noted that this duality of nancial transaction extended to the fact that nancial resources
transfer from one place to another. In other words, for every nancial transaction there must have been a transfer
of economic resources from a source to a destination. Again he applied the concept where the source would be
credited and the destination debited as nancial resources owed from one place to another.
He was so convinced of this concept of duality, that he is said to declare that no one should go to sleep at night
without ensuring that the credre equalled the debere. (credits = debits)
Note: The English translators used the Latin roots for these concepts and so named them Debits
and Credits. It is highly probable that we also got the abbreviated forms of these terms (Dr and
Cr) from the Latin roots as well, because there is no r in the English word Debit but there is one
in its Latin form Debere.
Summary
In Part 2, we see the emergence of the concept of duality where debits and credits are just two sides of the same
coin in the way that the Chinese concept of yin and yang are complementary opposites within a greater whole.
We begin to see the concepts that underpin the application of Debits and Credits and the link to the original Latin
root with its original meaning.

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PART 3 What are the underpinning concepts for Debits and Credits?
To properly understand Debits and Credits you will need to rst understand the concepts that underpin the whole
accounting process. Some of these are called Accounting Conventions and others are simply re-enforcing the
way that the accounting systems looks at and records nancial transactions.
Basic Accounting Concept 1 The business or rm is an entity.
In simple terms, the legal system denes an entity as a person or non-person that is capable of
suing or being sued under the laws of the land. In most countries of the world, companies are
given this non-person entity status and are given the same rights and obligations of individual
persons. Accounting takes this concept a step further by stating that every rm (including sole
traders and partnerships), creates its own accounting entity and that the income and net worth of
each entity must be calculated based on its own nancial transactions.
Basic Accounting Concept 2 The business (rm) is a separate entity distinct from the owners
A rm, while it has legal control over items of value, it is not the ultimate owner of those things. In
other words, if the rm sold everything it had, it would be obliged to distribute all those monies to
meet the claims made by other people or entities. The rms rst obligation is to pay the claims
made by external people (i.e. loans and creditors) with the balance being given to meet the claims
made by the owner(s). The business would then return to how it all began, as a blank sheet
without obligations or the control of any items of value.
Basic Accounting Concept 3 People can wear multiple hats.
While this a not a strict accounting concept, it is an important one to understand when getting the
right perspective on nancial transactions. Just like one person can be a parent, sibling, cousin or
an ospring, so too a person can be an investor in a rm, a creditor/debtor of a rm, the manager
of a rm or a director of a company that controls the operations of a rm. The important thing to
remember is, that in accounting the nancial transactions are always analysed and recorded from
the rms point of view with you as the manager (not owner).
Basic Accounting Concept 4 Every nancial transaction has two sides to it and involves a source and
a destination of economic resources.
The nancial world is a closed system. That is, money does not just arrive from nowhere and it is
not just paid into thin air. If money is received by one person or entity, it must have been given by
another person or entity and that in every traction involving nancial resources there must be a
source and a destination. This gives us our rst insight into the Debits and Credits system that we
use in accounting today.
Basic Accounting Concept 5 The prot from the rms activities belongs to the owners.
As understood from Concept 2, the rm does not really own anything, from an accounting
perspective. It may have legal rights of ownership or control, but fundamentally in accounting

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terms it is an accounting entity set up by the owners to manage their aairs. So, when a rm
makes a prot it does so for the owners benet, not for the rms. Remember, if everything was
sold o the rm would be left with nothing because everything of value would be used to rst pay
o liabilities with the remainder going to the owners.

Summary
In Part 3, we get to understand the accounting concepts that not only underpin the concept of Debits and Credits,
but the whole accounting system as well. We learnt that;
1. The business or rm is an entity.
2. The business (rm) is a separate entity distinct from the owners
3. People can wear multiple hats and operate in multiple capacities.
4. Every nancial transaction has two sides to it. (a source and a destination)
5. The prot from the rms activities belongs to the owners.

PART 4 How would they have applied Credits and Debits in the 1400s?

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As Lucia pointed out, the accounting system he documented was being widely used by the Venetian merchants.
These people seem to be the 15th century entrepreneurs. Lets say that a Venetian entrepreneur named Antonio
asked Lucia to record the nancial transactions of his new business (rm) prior to Luca completing his famous
Summa book in 1494.
(Note: For the purposes of this story we will use the $ rather than the Venetian ducat or Florences famous
orino doro golden orin and use the English accounting terms rather than the Latin)
The story goes
Antonio had spotted an opportunity to sell Italian olives to Egypt. Antonio thought he could make a killing. So,
Antonio (as manager of the new rm) approached an Italian olive provider and convinced him to supply $100,000
worth of olives but with the promise to pay him on his return from Egypt. Antonio did not mention the prot he
was going to make because the olive providers only interest was in being paid for the olives.
So, Lucia had his rst nancial transaction, and noted the following using the Latin meanings for Debits and
Credits:
The source of the economic resources was the Italian olive producer whom the rm now
owed $100,000 Credit (Cr) Accounts payable
and
The destination of the transfer of economic resources was the olives that the rm now had
as inventory Debit (Dr) Inventory
Using the Table 1 approach we would make the following entry:
Asset Inventory (increase)
Liability Accounts Payable Olive Provider (increase)

$100,000 Dr
$100,000 Cr

Soon after, Antonio took Luca to see the $50,000 ship he had bought, using $30,000 of his own money and
$20,000 from a bank (loan funds). Antonio was excited because he now knew that he had the means to make

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his idea a reality and make that fortune he dreamed of from selling these olives.
Luca realised that while Antonio was always speaking about what he had done, Luca knew that he was really
speaking about what the rm had done with Antonio as its manager.
Luca realized that the rm had been involved in its second nancial transaction and again noted the following
from the rms point of view:
One source of economic resources was the bank who the rm now owed $20,000 in the
form of a loan Credit (Cr) Bank loan
and
Another source of economic resources was the $30,000 from the owner Antonio who the
rm treated as a separated entity to itself Credit (Cr) Capital
and
The destination of the economic resources sourced from the bank and the owner was a
ship that was purchased for $50,000 Debit (Dr) Ship
Using Table 1 approach we would make the following entry
Asset Ship (increase)
Liability Bank Loan (increase)
Owners Equity Capital Antonio (increase)

$50,000 Dr
$20,000 Cr
$30,000 Cr

Luca was happy because in both nancial transactions (1) the total of the debits equalled the credits and (2) the
underlying concepts of the double entry bookkeeping system had been adhered to.
Summary
Armed with the underpinning double entry bookkeeping concepts and the concept of the source and
destination of economic resources, we attempt to see what Luca saw as he contemplated the entries that would
be made in the ctitious books of this 15th century business.

PART 5 Is there another way to look at applying Debits and Credits?

Today we look at Lucas notes and we discover an emerging pattern. It appears that Luca could use concepts of
source and destination of nancial resources to describe every transaction.
It seems that

on with the story.

Antonio was soon back in town after successfully completing his sales trip. Antonio explained that he (as

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manager) had sold all the olives for $200,000 and the trip had only cost $30,000 including the $1,000 interest he
paid to the bank. He explained that he had paid these amounts out of the sale proceeds and that he had visited
the Olive provider to repay his account. He also said that he had used $10,000 of the sales proceeds to buy
furniture for his house in celebration of a successful trip.
We soon realise that a third series of nancial transaction for the rm has happened involving ve main parts.
Part 1 The sale of the olives for $200,000 cash
Part 2 The Olive provider was paid for his outstanding account.
Part 3 The use of $30,000 of cash proceeds to pay for the trip costs and interest expense
Part 4 The withdrawal and use of $10,000 by Antonio (as owner)
Taking over from Luca, we will look at these transactions and apply the source and destination approach to
determining the Debits or Credits of the transaction and comparing the results with the table rule approach
identied above.
Here is what we would have come up with;

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All the account groups have been aected in this transaction, yet you can see that we still achieve the same
outcome using the source and destination approach as the learned-Table 1 approach, but there is
an underlying meaning to the questions and they are in keeping with Lucas original Latin meaning.
Summary
In Part 5, we explore the idea that all nancial transactions could be interpreted from the point of view of the
source and destination of economic resources. Having just two main questions, we are able to apply a dierent
and more meaningful approach to determining a Debit entry into the rms books, or a Credit one. We have
attempted to link this approach to the likely meaning that Luca Pacioli had for the terms Debits and Credits. So,
apart from learning and applying the logic of the Table 1 approach to your debits and credits, you could also
apply this alternative view developed from the rst principles of Luca Paciolis work using concept that the source
of economic resources in any transfer is credited and the destination of those economic resources is debited.

Additional resources
1. Chapter 21 of the Tao of Financial Information http://taonancial.blogspot.com/
2. Articles on bookkeeping and accounting

Conclusion Debits and Credits

The key learnings from this training session were:
1. To understand the origins of the terms Debits and Credits
2. To understand the reason it called Debits and Credits
3. To identify and comprehend the underpinning accounting concepts for Debits and Credits
4. To see how would they have applied Credits and Debits back in the 1400s.
5. To nd a meaningful way to apply Debits and Credits to nancial transactions.

We set out at the start of this article to understand more fully the basic accounting concepts of Debits and

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Credits. We know that we can be a successful bookkeeper by simply applying the learned Table 1 approach, but
some people want to understanding the why? By going back to the time of its conception, and looking at the
original meanings we have been able to give meaning and a new approach to determining the Debits and Credits
of nancial transactions.

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