Monday, April 19, 2010

How I Invented the World's Fastest Method to Learn Debit and Credit

Note: The method was invented in 1990 and published in Manila newspaper BusinessWorld in 1999. The Street Strategist's Financial Literacy Program, an accounting and finance crash course for non-accountants,  is based on this method.

In which the Street Strategist offers the simplest formulation of the fundamental equation of accounting
How I Invented The World's Fastest Method to Learn Debit and Credit
t is probably ironic that one of the most popular articles I've written that unburdened the loads of many non-accountants was borne out of my incompetence that burdened me for years.
I'm the most unlikely person to challenge the accounting world but I rebelled: “I am not psychotic. It's the entire accounting world that's psychotic. I'm not dumb. It's the entire accounting world that doesn't know how to teach.”
Who in his right mind would challenge 500 years of accounting dogma, especially on the very basic concepts of debit and credit? I hate accounting. Why bother? If millions of accountants don't find anything wrong with it, what professional competence do I have to reinvent the wheel?
My classmates were drowning in case studies, while I browsed every book trying to deconstruct accounting. What was my sense of priority? I developed the Accounting Wizard at the expense of my other personal pursuits.
Deconstructing accounting
The Accounting Wizard was published in 1999 but I invented the accounting codes in 1990.
These were my objectives: First, to derive the accounting equation. Second, to understand the role of debits and credits. Third, to formulate the simplest and the most unambiguous method of using debits and credits that cannot be further simplified. Fourth, to deliver in a short article an overview of accounting in the most intuitive manner possible that would serve as the mental map for the student.
That was very ambitious. The Accounting Wizard may not have the same impact on you as it had on me because we solved different problems. You just wanted to learn accounting; I wanted to learn why I couldn't understand accounting.
But I had one thing going for me. I had a framework – the fundamental theorems of mathematics. Is it possible to reduce basic accounting into the simplest and most fundamental concepts or definitions similar to what's done in mathematics?
Sources of confusion
I evaluated what I could understand and what I could not. Note that I did not use the word “know” because it is possible that I don't know about a topic yet I could understand it, once I set my mind to it. The difference is huge.
I finally identified what I didn't understand. There were two: First, I couldn't understand how the accounting equation was derived, if ever there was a derivation in the first place.
Second, I didn't know how to perform debit and credit operations, I didn't understand the purpose of their queer relationships with the accounts and, finally, I didn't understand why Pacioli and friends invented these twin ideas in the first place.
Fundamental theorems
We all studied algebra, but can you state the fundamental theorem of algebra, that is, the theory upon which all of algebra is built? Too hard? Can you state the fundamental theorem of arithmetic? Don't tell me, you don't know that either.
The fundamental theorem of arithmetic states that every positive integer can be factored in one and only one way into a product of primes.
The fundamental theorem of algebra (FTA) states that every polynomial of degree “n” with complex coefficients has “n” roots in the complex numbers.
In mathematics, there's a common phrase: “necessary and sufficient condition.”
To the mathematician this is an extremely powerful statement. This is a ruthless mandate to eliminate any unnecessary condition, or any unnecessary step, coupled with an equally ruthless mandate that those conditions that remain must be sufficient to prove a theorem or to prove the existence of a fact.
One example of this “necessary and sufficient” mentality is Euclid's approach to geometry. Euclid developed geometry based on five postulates. He established that the fifth postulate is necessary. For 2,000 years, mathematicians tried to reduce the minimum postulates to four but they failed to eliminate the fifth postulate. In other words, nobody could further simplify Euclid.
The deeper the mathematicians analyzed Euclid, the more they appreciated his genius in formulating and choosing the five postulates that are necessary and sufficient to derive the entire branch of geometry.
War of reasons
My first problem was how to introduce the accounting equation. After so many courses and so many years, I still didn't understand how the equation was derived.
They couldn't understand why I cannot understand the accounting equation; on the other hand, I couldn't understand how they could possibly understand the accounting equation.
Reduced to simple terms, for them the equation was obvious; for me the equation was not obvious.
This was a fundamental philosophical conflict of religious proportions. And I was at the losing end of the unilaterally declared war of reason because my role was limited to pointing out the lack of rigor (or even the lack of derivation) of the equation but nobody seemed to realize the lack of rigor except myself.
Going back, my first accounting professor probably had 20 years of accounting experience. He was a good accountant but not a good teacher for new students. Forgetting what it was like to be a new student is the teacher's cardinal sin and the student's worst nightmare.
On the first day, he wrote the accounting equation: Assets = Liabilities + Capital.
Spinning my head instantly, it was.
Reason: For the life of me, I couldn't understand why liabilities and capital added up together must be equal to assets. The logic of the equation might be obvious to you but not to me.
I know that millions of accountants out there can justify that the logic of the equation is so obvious. But please allow me to explain why it is not obvious to me.
Whenever I see an equation, I always attempt to understand it. If it is a mathematical equation, I study its derivation. But A = L + C? I couldn't derive it. All those teachers did not attempt to derive it, neither did they find any need to. In whatever manner they explained it, it was not rigorous, and not intuitive enough for me.
But it seemed nobody in class was bothered by the lack of rigor of how the accounting equation was derived. So I figured I just wasn't perspicacious enough. It was another case of knowing without understanding.
As recently as a few days ago, I received this: “I don't recall any origin of the equation, but it must have been invented, to establish accountability and to safeguard its integrity.”
Correct, but not rigorous enough for me.
In fairness though, the teachers tried to rearrange the equation into A-L=C, which was understandable but still not intuitive enough for me, especially since the balance sheet was formatted in terms of A= L+C.
I thought there was something wrong in the way it was taught. But I was too embarrassed to admit I had absolutely no clue regarding the accounting equation. Probably, only a mathematician could empathize with me.
I envied those students who breezed through this simple equation. As for me, I regarded the equation as some magic rammed down my throat. It was my first taste of accounting magic.
Now, don't get me wrong. I don't know everything about accounting, yet I can accept that. It's called ignorance.
But if I cannot understand something that I know, that is called incompetence. And that is unacceptable.
However, the accounting world goes on, despite one confused individual. My only consolation is that it took hundreds of years to prove the fundamental theorems of arithmetic, algebra and calculus.
Mathematicians had been using, without understanding, these theorems. But they were not too proud to admit they didn't understand the theorems enough to prove them. The FTA proofs failed because they assumed – not questioned – the existence of the roots.
In the same manner, I assured myself that, perhaps, accountants made the same mistake, that is, they assumed the existence of the accounting equation even without a rigorous derivation or proof.
This was a more reassuring thought than admitting I was too incompetent to understand an equation that was obvious to everybody else.
Not having luck in finding a way to introduce the accounting equation in a rigorous or intuitive manner that satisfied me, I skipped the topic altogether and moved to the financial statements.
I decided to introduce the financial statements with the barest minimum definitions that would stick to a beginner's mind. But the definitions given in textbooks were too complicated for a 30-minute overview. Plus, they introduced concepts in the definitions that were unnecessary in violation of my guideline to use only “necessary and sufficient” concepts or conditions.
So then I started to define the balance sheet. After several months of figuring the simplest but most sufficient definition, I finally came out with one: It is simply a listing of all the company's assets. But I added this phrase that looked very intuitive to me: “showing the proportion of how they were acquired, either through borrowing or using its own capital.”
For you, that is nothing. For me, that was the most powerful accounting concept that knocked on my confused head. In providing some sort of a “geometric interpretation” of the balance sheet as a proportional combination of how the asset was acquired, I had in effect, “discovered,” the fundamental accounting equation assets=liabilities + capital.
When I use the term “discover,” I refer to my own personal revelations which, as I have pointed out earlier, were so obvious to you in the first place.
That's when the flash of understanding hit me. Given this definition of the balance sheet, the accounting equation comes out as a natural consequence of the definition. There was no longer any mystery or magic as to how A=L+C.
That, for me, was a bolt of lightning. I had finally found the most intuitive derivation of the accounting equation, not as a magical relationship rammed down my throat.
The traditional way is simply stating without deriving that the sum of liabilities and capital must be equal to assets. I proposed that the concept should be intuitively stated as “assets are always acquired by a combination of liability and capital, therefore automatically A=L+C.”
What was to me unnatural, illogical, and counter-intuitive many years ago, was now the most natural, logical, and intuitive equation of all.
And I discovered the accounting equation by accident – in attempting to formulate the simplest possible definition of a balance sheet using only the necessary and sufficient conditions.
Inventing the six codes
Then I decided to discuss the basic three financial statements first to give the beginner an idea of what to expect from accounting.
There were nothing conceptually great about the income statement and the statement of cash flows.
I decided to postpone any attempt at discussing debit and credit in order to show that understanding accounting is possible without the use of DR and CR.
The conceptual problems I faced with debit and credit were enormous. Were these two concepts necessary? Since I couldn't understand the debit/credit concepts, I skipped it temporarily and I tried to understand the rules first.
Most of the debit rules I came across were redundant. I couldn't believe the accountants were wallowing in all these redundancies. How could a normal mind absorb all these redundancies? I came to the conclusion that these accountants were brainwashed, not taught. They were fed with the rules, not taught to derive them.
In contrast, in math and physics, the students compete by providing different derivations of the same rules or equations. Plus the “necessary and sufficient” mentality, plus the “fundamental theorem,” mentality.
So I painstakingly studied all debit/credit rules. I grouped them into derived, and fundamental rules. Then I removed the rules that were not “necessary,” and maintained only the rules which were “sufficient.”
Voila, the entire bookkeeping imbroglio was down to only six rules which are necessary, sufficient and fundamental. All the other rules can be derived from the six rules.
Thus the Street Strategist's Accounting Codes were born.
The secret
After inventing the codes, I was now ready to attack the concept itself of debit and credit. It took me months to figure out that the intuitive way to learn debit and credit was to unlearn them.
Eventually, in my mind, the greatest mystery of accounting crumbled, and I came up with a snappy guideline: The secret to understanding debit and credit is not to understand them at all.
Even after reading the Accounting Wizard, many CPAs come back to me with their own shortcuts using tables or matrix. I must say I have been there, done that. Before Wizard was published I have had ten years of studying if there were any simpler, easier, faster way than the SS codes.
Charts and matrices are not that effective and the memory part is hard as you have to memorize them in your head. Also, how do you expect a computer programmer to encode a chart in his software?
To dramatize which method is better, think of a quiz game where 10-year-old kids answer either “debit,” or “credit.” The catch is that each kid will be coached by his parent who will have only 10 minutes to teach the child the rules of debit and credit.
An inventor who finished only first year high school reacts: “So that's why credit and debit never made sense! Nice to know I'm normal.”
From an investment house CEO with an MBA:
“Funny, I at first, had a hard time understanding it and I believe it is because we have been “brainwashed” in school about what debit and credit are. I now think my professor was just as confused!
However, after freeing myself from the concepts already ingrained in our brain, the light bulbs in my head started to light up. Hopefully, they don't blow up!
I'd like to present your concept to my 9-year-old. This way, he will understand the whole accounting concept before it is corrupted by the traditional way of teaching.”
Audit Executive
From the highest ranking auditing executive of one of the largest banks in the country: “Fantastic! Your six codes are concise and clear and your style is the simplest way of explaining debit and credit to non-accountants.
By the way, I was entertained by the manner by which you presented your thesis. Am sure there's a big market out there waiting and very much receptive to your expression style.”
Wharton MBA
From a Wharton MBA who's currently a consultant with the country's largest accounting firm: “A great article, indeed. Your reducing accounting to a few codes is good for us non-accountants. For me, the basic lesson in accounting is to determine from whose point of view are the terms being read; this is something that you clearly set up.”
From a college comptroller: “I find your example on how the bank statement terminologies can be confusing for non-accountants, very amusing.”
Intuitive focus
Here's another reaction from a banker: “Your theory that the left of T account is always DEBIT and the right of T is always CREDIT regardless of the nature of the accounts, is something that hit me, an accountant by education and a banker by profession. Probably because having been bombarded by debits and credits all the time I never realized or visualized what was happening every time entries in the book are being made.
“Your six codes which focus only on INCREASES of the Balance Sheet, Income Statement and Cashflow Statement accounts are, I believe, the best shortcuts for the debits/credits principle.”
Saudi Arabia
From a CPA in Saudi Arabia, in one of the largest oil companies in the world: “You said your paper was never intended to be useful, but indeed it is very useful to just about everyone who is concerned with finances. It is also useful to students of MBA but only at the time they would be reading and analyzing or interpreting financial statements.”
VP Human Resources
From a VP in Human Resources of an engineering firm: “I didn't realize it was that simple. You were right, I agonized trying to understand debit and credit in my MBA course to the delight of my professor. What you presented is a simple process any average man on the street could learn. Was that why you called yourself Street Strategist?”
US Asset manager
From a US asset manager: “I found it to be a wonderfully written piece, which is absolutely perfect for beginning non-accountants who wish to get to the root of financial accounting and sweep away the haze.  In my opinion, you have succeeded in providing the accounting-challenged, in an enlightening and comprehensive fashion, with the welcome relief they need from their financial ignorance in 30 minutes or less, indeed.”
From an engineering PhD: “I was wondering why debit and credit never showed up in the financial exams I took; and your Accounting Wizard reinforces my belief about their relative irrelevance despite their ubiquity. Your six codes will surely help me keep bookkeeping, debit and credit, at bay.”
The greatest irony
Now go to your resident mathematical genius and ask him to state the fundamental theorems of arithmetic, algebra, and calculus. He will not be able to state all three. Trust me, the most fundamental things are the easiest to know but the hardest to understand.
One last thing before I go. Just to give you an idea of how difficult it is to prove the fundamental ideas, the fundamental theorem of algebra was first proved with some gaps by Gauss, the prince of mathematics at age 21, a feat that eluded the greatest mathematical minds of all time including Euler and Leibniz.
Little is known, however, of a Swiss named Argand who beat Gauss by formulating the simplest of all proofs to the algebra theorem.
This was no ordinary feat, although his proof was not rigorous enough because it contained some gaps. The novelty of this proof was in presenting a geometric interpretation of imaginary numbers as 90-degree rotations.
Overall, it may sound ironic that it took a non-accountant like the Street Strategist to advocate the intuitive self-evident nature of the accounting equation, and to invent the six fundamental codes that facilitated the simplest approach the most fundamental operations of accounting.
However, this may be the most ironic twist of all: the genius who outsmarted Gauss who was considered the prince of mathematics at his own game, the algebraic genius who formulated the simplest proof to the single most difficult fundamental theorem of mathematics, the person who revolutionized algebra with his intuitive geometric interpretation of complex numbers, was Jean Robert Argand, who was widely known as –surprise, surprise – a professional bookkeeper and accountant. But of course!
Thus it came to pass that Jean Robert Argand, a professional accountant, crossed over to offer the simplest proof to the fundamental theorem of algebra.
On the other hand, the Street Strategist, a student of algebra, crossed over to offer the simplest formulation of the most fundamental equation  and operations  of accounting.
This is probably one of the greatest ironies of our history.
(Thads Bentulan, April 18, 2002)
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  1. Anonymous12:45 PM

    Where can we find your method? Do we have to buy a book or attend a seminar?

  2. Anonymous8:09 AM

    im interested in your method. how can we get it?

  3. So where is this method!?