To fully understand the accounting equation and financial data in general, we need to have an accurate definition of the terms “debit” and “credit.” These two terms are historical and their origins are of semantic significance. What a bookkeeper does when he records a transaction with debit and credit entries goes to the very essence of financial information.
For starters, debit and credit are not Latin words for “left” and “right,” despite claims of various textbooks. The whole financial world would work unchanged if debits were recorded on the right rather than the left. Within the computers that process accounting software, left and right have no real meaning. If debit and credit have any significance in producing critical and accurate financial information, they are not substitute terms for left and right.
And, despite authoritative claims to the contrary, debit and credit do not change their meaning as we go from the left side of the accounting equation to its right.
Assets = Liability + Equity
A debit to the Assets side of this equation behaves exactly like a debit to the Liability term on the far side of the equal sign. It increases a debit balance equally on both sides; it decreases a credit balance exactly the same in both places; and in all cases, a debit represents an increase in the amount of financial resources available at the location to which it is applied. Most importantly, the terms debit and credit were used exact as they are today for several hundred years before the Accounting Equation did. The two terms are in no way defined by the Accounting Equation itself.
Returning to the Latin sources of the terms, they have simple meanings that describe exactly their role in double-entry bookkeeping and reveal exactly the underlying meaning of all financial data. A debit is a Latin term that serves as a root for our modern term “debt.” It represents a deposit of something from some other place. Its original use in accounting and its use in modern financial data remain consistent with its original Latin meaning; a debit is a deposit of financial resources, regardless of which side of the accounting equation and which side of the t-account that it is recorded upon.
In turn, credit is derived from a Latin term meaning the source of a deposit. This also is consistent with modern bookkeeping entries that credit revenue, equity, and liability accounts when they serve as sources to deposits to cash and other asset accounts. This is also consistent with the application to credit entries to the cash account when that account serves as the source of deposits to expense accounts
Accounting debits and credits are just records of deposits and withdrawals as financial resources flow from one place to another in a defined financial space. As a withdrawal, a credit is the opposite of a debit and numerically is accurately used as a negative debit in parts of the accounting process.
The problem is that the polar opposition between debit and credit is often obscured by the inaccurate application of the Accounting Equation, rendering modern accounting fragmented and subject to unnecessary rules that need to be learned by rote memory. Correcting the arithmetic in the Accounting Equation would make all financial data simpler and more accessible to the average person.
Assets + Liabilities + Equity = 0
And this, in turn, would make critical financial information more available to those who allocate the financial resources of our economy.
Posts
