Snippet #14 The Origins of Debit and Credit

Let us rewrite what Luca said: Money entrusted by owners to business = Money owed by business to the owners.

Now, let me make a little change to the highlights.

Money entrusted by owners to business = Money owed by business to the owners.

Can you spot the difference?

The left side, in addition to money, emphasizes the ‘person’ who is acting as a Source of Funds for the business to compensate for the purchase of assets (or, to finance the assets). In practical application too, Sources of Funds or, the Equity-Liabilities side of the Balance Sheet is a simple list of people and/or lending institutions who have put their money into the business with the hopes of being repaid handsomely.

(In case you want a recall of the Balance Sheet, here’s the link: Financial Statements. Now, back to the topic.)

The right side, with no change in highlights, represents only a monetary value. This value, in real life, may refer to cash lying idle in the drawer without any use. On the contrary, it may also refer to a group of items or a group of ‘assets’ that were bought using that cash and also includes the remaining cash.

That is to say, ‘money owed’ changed its form and from being only cash or bank balance at first, it now represents a sum total of various Assets.

Since these assets are supported using funds provided as Equity and Third-Party Liabilities, they are entirely owed to Owners and Lenders.

An important thing to mention is that lenders simply wish to earn their interest income and hence, usually claim only a fixed portion of the cash / bank balance. They do not claim other assets unless, of course, in the case of non-payment of the loan instalments.

Now that the equation is clear, let us proceed further.

Luca gave labels or tags to the two sides of the equation. These tags were called:

1. Debere which means ‘To owe’. This tag was given to Money Owed.
2. Credere which means ‘To Entrust’ and, was given to Money Entrusted.

The words Debere and Credere originate from Latin but with the passage of time and increased use of English, they became debit and credit respectively.

Debere = Credere or, Debits = Credits. This idea became the foundation of Luca’s Double Entry System of Accounting which we use till this day and Luca or rather, Luca Pacioli came to be known as the “Father of Accounting”.

This was the story of the origins of debit and credit, both of which are merely tags used by Luca to represent each side of his statement/equation.

I hope that this was a relief for all the distressed commerce students and as for non-commerce students, consider yourself lucky.

Luca’s findings and their evolution to today’s accounting equation can be visualized as follows:

Next, we’ll lay some premises to test the use of our Accounting Equation. But before that, do read this post thoroughly and to further your understanding, I strongly recommend that you go through 2 small videos linked in the reference section.

Reference

Peter Baskerville – YouTube Channel
1. Video-1: Debits and Credits – Founding Principles
2. Video-2: Debits and Credits in Accounting – History and definition