Double-entry book-keeping is the what underpins modern accounting. All good accountants can 'speak' it natively and are able to break a complex series of transactions down into debits and credits. But what is it, exactly?

Double-entry book-keeping was first popularised by an Italian, Luca Pacioli, who was a mate of Leonardo da Vinci's. Its genius is that it records a transaction twice. This is reminiscent of Newton's idea that every action has an equal and opposite reaction, but has a truly amazing side-effect. It allows you to double-check whether you have recorded entries properly. Because, if you have entered in a transaction with unbalanced entries, your resulting ledger will not balance. In a stroke, and several hundred years before the computer, Pacioli had hit upon a way to introduce in-built checking to accounting.

The equal and opposite sides are called 'debits' and 'credits' by accountants. Every transaction has debits and credits that, taken together, match. In other words, the sum of all the debits equals the sum of all the credits.

Here's where it gets a bit esoteric, but you'll just have to bear with me. A 'debit' is either something the business owns or is something the business has expensed. A 'credit' is either something the business owes or is something the business has earned. This allows you to construct some fairly complex situations.

Let's try out a transaction. Later on, we'll get into some really complicated stuff. Imagine an entrepreneur setting up a company with £1,000. What would the entry for this transaction look like?

After the transaction, the company has cash - of £1,000. So we know that this transaction will have a debit of £1,000. We also know that we have to find a credit of £1,000. It's not earnings, because the company hasn't done anything yet. So it must be something the company owes. And that's what it is - the company 'owes' the £1,000 back to the entrepreneur. We call that 'capital' to reflect the idea that the company can't distribute that money as a dividend; it's needed to protect the company's creditors (when it gets some).

In accounting convention, we would write the entry like this:

DR  Cash £1,000
    CR  Capital £1,000

That's all for now. More complicated transactions will follow in later lessons. Please ask questions if this isn't clear!

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Filed under: Accounting 101 with tags double-entry book-keeping, introduction to double entry book-keeping, isaac newton, leonardo da vinci, luca pacioli