Welcome to this 3 part series, we will try to explain the ins and outs of a business’ credit and debit process. We’ll explain the jargon, the processes and what your accountant does behind closed doors.
Summary
Ever had problems understanding your accountant? Do they come by from time to time, collect some invoices and bank statements then magically re appear with Annual Accounts to sign off and a copy of their invoice? Like witch doctors of old, they guard the dark arts of a complex tax system to mystify the villagers with the sacrifice of a cheque to appease the capricious gods of HMRC. They come shrouded in mists of cynicism and a disclaimer as long as your arm. They rarely explain how the accounts are prepared as we willfully obey by signing pages 5, 7 and 9.
Most accountants that I have dealt with do genuinely keep up with the tax changes and try to do the best for their clients. Yet many directors are not necessarily trained in finance to fully appreciate this strange language of debits and credits, balance sheets and depreciation schedules that are presented before them. At the end of the day it is the director who is responsible for signing off the financial statements of a company, and not the accountant. In this series we attempt to demystify finance speak so next time your accountant comes in, at least you can ask some educated questions and begin to appreciate financial statements and what they mean.
Part 1: What is double entry bookkeeping
Most business’s that I go to, I ask to check the Profit loss, balance sheet and trial balance financial reports, I need to check the accuracy of the books prior to upgrading their accounting systems to an enterprise level, as this impacts on the effectiveness of the new system. In nearly all circumstances, regardless of the size of the organisation, there are errors in the accounts. Some of these issues need to be fixed before I can proceed with the install. When I enquire further into how this came about, there seems to be a distinct lack of basic understanding of debits and credits and on which side they should go. This is usually because a staff member got lumbered with “doing the books” with little or no training and there is an over reliance on “the computer will do it for me” without a full appreciation of what is happening in the background. This is not necessarily their fault as even people who have studied existing courses aren’t taught the basics, let alone how to apply them. On my first bookkeeping course I was just told that a “There are debits and credits but they could go the other way”. Ka???
The best explanation of accounting was told to me by a senior accountant who was very disparaging of her profession. She would tell the story of two peasants in the middle ages who would trade one bag of carrots in exchange for a bundle of turnips as a straight barter. It wasn’t until one day when the peasant with turnips said his crop wasn’t ready but could he take the bag of carrots now and pay his bundle in 30 days’ time? The peasant who sold the carrots said that was fine, but I’ll need to write that down otherwise I’ll forget, and thus for our sins, accountants where born. The exchange of carrots and turnips would have just been a single entry of in and out for either side of the deal. As soon as you introduce a timing difference then it creates a double entry, one when the transaction has occurred and the other when the transaction is paid. Under the original arrangement:
Peasant A sells a bag of Carrots and would receive bundle of Turnips.
Peasant B sells a bundle of Turnips and would receive bag of Carrots.
That is one record as the sale equals vegetables given and received.
Under the new arrangement:
Peasant A selling bag of Carrots – Needs to record sale and that he is owed a bundle of turnips from peasant B. Each transaction has two consequences even though it is the same figure. The amount of the sale, and what is owed. When it comes time for Peasant B to pay, Peasant A, he has to record that he has received the bundle of turnips and that Peasant B has cleared his debt. There are now two transactions, one as the sale and amount owed, and later the payment (in vegetables) which discharges the debt, thus creating a double entry.
For our interactive example go to our downloads page for “Example of Stock movement” widget
