A Little Bit of Algebra

It is a tribute to our human ingenuity, that the bookkeeping algorithm described by Pacioli is as simple as it is. There are really only 2 very simple equations that form a part of the algorithm:

2 Underlying Equations:

  1. For each transaction the sum of debit parts is equal to the sum of credit parts
  2. The sum of assets is equal to the sum of liabilities plus the sum of equities (aka “the balance sheet equation”)

 

While the table shows 5 types of accounts, the revenue and expense accounts are really a subset of equity. These ‘income statement’ accounts are also referred to as temporary ownership or equity accounts. Each year they are reset to zero and ‘closed to equity’.

However, in spite of the simplicity of the structure, the implementation is actually challenging. This is borne out by the fact that Xero – a leading developer of online accounting software for small business – by 2013 had invested about $250 million (since 2006) in developing their application and were still not profitable despite more than 200,000 users.

Even the acknowledged leader – Intuit’s Quickbooks – puts a staggering 80% of it’s R&D budget into their 2 market leading applications – TurboTax and Quickbooks.