1 Introduction to credits and debits

Early confusion

Accounting notations is confusing, mostly because early renniasance mathematicians did not like negatives numbers. So instead of using negatives they used Credit and Debit.

So I am going to show how to do it with transfers. This is not my idea but Martin Kleppmann’s who wrote a nice blog post about it in 2011.

2 Show a deposit into a bank

The question is how does the bank represent this in it’s accounting system?

In this case Cash assets is our bank acount.

If we stored the banks money in a piggy bank and customers gave us real money. Then cash assets would represent the piggy bank with £25 in it.

The other thing to note is that the customer account is negative. This is because the bank owes the customer £25. In accounting terms this is called a liability.

3 Accounting notation

Comparing the two notations - on the top we have the simple transfer notation and on the bottom we have the accounting notation.

We can reverse the whole process, when a customer withdraws money from the bank. The bank now has in this case zero and the customer account is zero.

Why did we do it this way around? Because it represents the actual transfer of money. After the bank has received the money it has 25 pounds to play with as well as owing the customer £25.

4 Simplest bank

This is a representation of the simplest bank like a safety deposit box or a piggy bank. The money in the bank does nothing but is just returned at will.

However, this is not a very useful bank. It is just a safe place to put your money. So a real bank needs to make the money earn interest so that they can pay interest to the customer. The next most simple bank is a Ponzi scheme were the bank does nothing with the money but just pays “interest” on it from the accounts it holds. This eventually collapses.

5 Ponzi bank

Here is a diagram of a Ponzi bank, with a couple of customers. From now on we will just looking at movements of money as seen within the bank.

This shows the bank with two customers after each have made one deposit each and been paid interest at the end of the year. Note the sign of the interest paid is -ve, the bank is losing money on pyaing interest.

To calculate the profitability of the bank we need to look at expenses (there is no revenue). This is positive which is a loss.

6 Real bank

Here is a diagram of a real bank, with a couple of customers. It is like the ponzi bank but pays a lower rater of interst. It puts the bank money to work by depositing it in the Bank . From now on we will just looking at movements of money as seen within the bank.

This shows the bank with two customers after each have made one deposit each and been paid interest at the end of the year.

At the end of the year the bank has earned £3 of interest and credited to the customer accounts £1.50. So the bank has makde a profit of £1.50

The customers fund are represented by the £30 at the customer accounts and 3 in it own accounts. For a net of £33 and owes its customers £31.50 Making a nett profit of £1.50

Accounting notation

You can show the same transfer using accounting notation:

Using conventional accounting terminology the same arrangement can be looked at like: