I’ve been looking at this accounting software, gnucash to keep track of my money (Ha! Like I really need a computer to do that. My dog could add these numbers, they’re so small.)
Anyway, this software uses so-called double-entry accounting. I get the overall system for the most part, but the more I read the documentation, the more everything makes no sense whatsoever.
Now, I have an analytical mind. I failed Calculus three times in a row, after all. I should be able to understand accounting.
I get the following:
Every transaction I make is moving money from one account to another. (or multiple accounts, but we’ll keep this simple.)
There are expense accounts and income accounts. This seems to make sense. If I pay a credit card bill, the money goes from my checking account to my credit card account. The credit card account is an expense account, so it subtracts that money from my net worth.
If I get a pay check, it goes in my income account. But where does it come from?!
I still don’t know how to set everything up. The manual talks about equity accounts and withheld earnings; all I can figure out is that this has something to do with my Opening Balance. I know how much money I have right now, so I should set that as my opening balance, right? What account does that go in?
I used to know what the word “credit” and “debit” meant. Now I have no clue.
My brain is about to explode. This is a lot simpler than I think it is.
Double entry accounting is basically a check on people making mistakes. For every transaction (paying wages, recording sales, buying fixed assets) there are two entries. Both are for the same amount, and one must be a debit while the other must be a credit. Anything else and you’ve made a mistake – which means your accounts won’t balance and you’ll spot the error. If accounting involved single transactions you might make mistakes and never notice…
It’s not necessarily about having two accounts – but a lot of the time, business accounting involves two main types of account. The balance sheet is a financial snapshot of a business’ net worth at a given moment in time. The profit and loss account is a statement of the movement of assets over the course of the financial year.
This is where it gets tricky. Check out this thread for more on credits and debits. I said this about them in it:
Or just remember this: in a balance sheet, a debit is A Good Thing and a credit is A Bad Thing. In a P&L it’s the other way round.
To answer your specific question a little better, “accounts” in double entry accounting is a theoretical concept, not related to actual accounts you may have. The accounts (also known as ledger accounts or T-accounts) are simply ways of classifying your assets, liabilities, income and expenditure – sales, amounts owing from debtors, rent expenses, amounts owed to creditors and so on.
Each double entry transaction will affect two of these accounts (I can’t remember if there are any exceptions, and none spring to mind). When you eventually close all of the accounts off at year end, they should all balance.
For example:
[ul]
[li]When you pay wages, you credit your cash “account” (remember the terminology in the post above!) and debit your wages expense “account”.[/li][li]When you make a sale, you debit in your cash “account” and credit your sales figures.[/li][/ul]
The key is not to confuse these ledger classification accounts with real life accounts. They’re just not the same – double entry refers to placing two sides of a transaction (the “to” and “from”), not about where the money actually is.
Double-entry accounting is essentially tracking every cost or income by two separate methods. Also, you don’t ever use negative numbers; hence every account will have both debits and credits, eventually [some business accounts only get zeroed out once every fiscal year]. This can be a good thing, if you are reduced to keeping track of everything on sheets of paper. Modern electronic methods make a lot of the processes used seem rather pointless though, such as different various summary pages. For instance, for a personal account, you could have separate sets of records (sheets/books/whatever) for cash purchases, or credit purchases, or checks you write (which is sorta the same as cash, but maybe not, depending on how much you wanted to separate anything). - Electronically, it’s easier to classify every transaction by type and put them all into a single database that you can run queries on (instantly selecting by whatever criteria you want) and then export the results to a spreadsheet to do whatever you want. If you’re a programmer type you’re saying “Well, DUH gomer” but before computers that wasn’t possible.
Well, assuming you’re going to follow this double-entry business to its grisly end, it comes from the Accounts Receivable acct for your employer (we’ll use McDonald’s).
Let’s say you have (for this example) three accounts in your records:
Hours Worked -->the amount of time you have worked.
Accounts Receivable McDonald’s–>this is money you have worked for that you have not been paid yet.
Cash–>money you actually have right now to spend.
When you worked for your employer (for say 10 hours), you should credit (right side) “10 hours” in the “Hours Worked” acct, and debit (left side) “10 hours” in the Accounts Recievable McDonald’s acct (this is money that your employer now owes you). When you actualy get paid, you credit “10 hours” in the right side of the Accounts Receivable acct for your employer (which should zero it out, because they have now paid you all they owe you) and debit the amount you got paid in the left side of the Cash account. The Cash account representing the money you actually have, as long as the left side is more than the right side.
-Kinda hairy for tracking personal expenses, me thinks. - MC
Salaries owed would be a credit in the employer’s Accounts Payable account, and would be resolved by them crediting their cash (i.e. reducing it), debiting their A/P account (i.e. reducing their liability to you). When that money reaches you, you’d debit your cash (i.e. increase it) and credit your debtors account (i.e. reducing the amount other people owe to you).
Summary:
Employer
[ul]
[li]Credit cash (reducing their cash asset)[/li][li]Debit creditors (reducing the amount they owe other people, i.e. you)[/li][/ul]
You
[ul]
[li]Debit cash (increasing your cash asset)[/li][li]Credit debtors (reducing the amount you are owed by other people)[/li][/ul]
friedo, I feel your pain. I passed calculus, and this is making my head hurt.
It may or may not be of any real help, but I did stumble across this site, which purports to be a tutorial on (double-entry) accounting (Click on “Accounting Guide”). They’re British, so it’s all buying petrol for £10, and stuff like that. That detail can’t possibly confuse me any more than I already am.
Probably like you, I simply cannot wrap my mind around the terms “debit” and “credit”, and what they actually mean. The minute “money I owe” gets renamed “accounts payable”, my eyes start to glaze over…
That’s correct as far it goes, but you are not tracking the hours worked, and I am, and you need to.
-And I’m not talking about McDonald’s books, I’m talking about friedo’s. What other people do with their books we don’t care about here. For your own books, the accounts receivable is what other people owe you, and the accounts payable is money that you owe others. Money owed to you is an asset, and assets are increased with a debit (on the left side of a T-account or 2-column record).
The “10 hours worked” entered in the right side of the “Hours Worked” account is used to allow you to enter the amount of pay that McDonald’s owes you in the debit (left) side of “Accounts Payable-McDonald’s”. In double entry bookkeeping, every entry has to affect at least two accounts on opposite sides, else things don’t balance, -and money owed to you is an asset, and so has to be entered on the left side. In my example, the “Hours Worked” is ‘What You Did To Get Paid’. The “Accounts Receivable-McDonald’s” is what you are owed for the work you did [but haven’t been paid for yet], and the Cash is what tracks the money when you actually get it. You can’t get paid for not doing anything, but to be able to check if you got paid right, you need to track how much you worked separately from what you got paid. The last line of your post mentions “crediting debtors” but you have not included any way of doing that. You must record the hours worked. When you balance out your accounts, the amount/pay of “hours worked” will/should equal the amount of “hours paid”. Get it?
The “Hours Worked” would only normally be zeroed out by a closing entry at the end of the month or year or whatever. You wouldn’t have anything debiting your “Hours Worked” because once you’ve worked them hours, you can’t get 'em back. You have “lost” them, so they are a liability, any eager optimism of youth aside.
-And actually, instead of “Hours Worked”, I should have named it the “Value of Hours Worked” account. The number of hours isn’t really directly of much use, unless you are willing to track pay rate changes somewhere (!). - MC