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Teaching debits and credits – unnecessary complications

September 21, 2011 Leave a comment

In returning to teaching transaction processing, I have been struck by the unnecessary complications created by the variety of way appropriation transactions are recorded depending on the legal structure of the entity.

In proposing a reduction in these complications, I am assuming two points:

  1. Most accountants who are involved in the recording of transactions will be working for companies
  2. Pedagogy must overrule practicality when teaching

The key area of confusion is the accounting for distributions to owners:

  • In sole traders, the drawings account is closed to capital
  • In partnerships, each partner’s drawings account is closed to their current account
  • In companies, the dividends account is closed to retained earnings

While there may be some merit in retaining the terminological distinction between drawings and dividends, I can see no merit in using different closing entries.  All entities could close their appropriation accounts to retained earnings; albeit in the case of partnerships, each partner would need a separate retained earnings account.

Teaching debits and credits – gripe about account names

September 16, 2011 Leave a comment

The texts I am using to teach transaction processing complicate matters by the way they name some accounts.  I’m not going to incite a defamation suit by naming the texts.

My pet hates are:

  1. Using the word “revenue” in a liability account or the word “expense” in an asset account
  2. Not clearly indicating the classification in the account name

First, “unearned sales revenue” is a liability account; “sales revenue” is a revenue account.  How is a first-year student meant to recognise the difference?  Similarly, “prepaid insurance expense” is an asset account while “insurance expense” is an expense account.

This source of confusion can be overcome easily by adopting some simple rules:

  1. Never using the word “revenue” in an account name unless it is a revenue account.
  2. Never using the word “expense” in an account name unless it is an expense account.

“Unearned sales revenue” could be called “deposits received”; “prepaid insurance expense” could be called “prepaid insurance”.

A related gripe which, fortunately, seems to have disappeared from modern texts is using the term “provision” in the name of contra-asset accounts.  The term “provision” now seems to be restricted to liability accounts which is the way it should be.

Second, some account names fail to indicate the classification of the account.  For example, an account named “supplies” could be either an asset or an expense account.  While I can determine which it is from context, a first-year student is likely to struggle to make this determination.  This problem can be overcome by including the classification in the account name when there is any ambiguity; this means the account would be named “supplies asset” or “supplies expense”.

Some may argue that the account names which are used in the texts are the account names commonly used in practice.  This may well be so.  However, when writing texts, pedagogy must always overrule practicality.

I hope some textbook authors, editors and publishers are reading this.