Basic Accounting Concepts - what am I missing?

[Jim Smith]

On Sun, Jan 2, 2011 at 12:40 PM, Ryan Flegel <rflegel at gmail.com> wrote:

> On 2 January 2011 11:21, Jim Smith <jimsmth761 at gmail.com> wrote:
> > On Sun, Jan 2, 2011 at 3:33 AM, James Kerr <
> jim at jkerr82508.free-online.co.uk
> >> wrote:
> >
> >> On Sun, 2011-01-02 at 00:20 -0500, Jim Smith wrote:
> >> > >
> >> > > On Sun, Jan 2, 2011 at 12:00 AM, Ryan Flegel <rflegel at gmail.com>
> >> wrote:
> >> >
> >> > On 1 January 2011 22:50, Jim Smith <jimsmth761 at gmail.com> wrote:
> >> >
> >> > > When one writes the Accounting Equation in the form shown below, it
> >> >
> >> > > doesn't make any sense to me.
> >> >
> >> > > (Assets - Liabilities) + (Expenses - Income) = Equity
> >> >
> >> > >
> >> >
> >> > > If I start off with 1 million in assets and no liabilities and then
> I
> >> >
> >> > > encounter 1 million in expenses and have no income, I should end up
> >> >
> >> > > with zero equity. The equation makes it seem like this scenario
> would
> >> >
> >> > > give me 2 million in equity.
> >> >
> >> > >
> >> >
> >> > > What am I missing?
> >> >
> >> >
> >> > > You've got it mixed up I think. It should be:
> >> >
> >> >
> >> > > (Assets - Liabilities) - (Expenses - Income) = Equity
> >> >
> >> >
> >> > > Note the subtraction of (Expenses - Income) instead of addition.
> >> >
> >> >
> >> > > --
> >> >
> >> > Ryan
> >> >
> >> >
> >> > Ryan, maybe I'm a bit rusty on my algebra, but I think your equation
> >> works
> >> > out to this:
> >> >
> >> > (Assets - Liabilities) - (Expenses - Income) = Equity
> >> >
> >> > Assets - Liabilities - Expenses + Income = Equity
> >> >
> >> > Assets - Liabilities  = Equity + (Expenses - Income) <-- not correct
> >> >
> >> > So I'm still confused
> >>
> >> The equation is (Assets-Liabilities)=Equity+(Income-Expenses)
> >>
> >> which means Equity=(Assets-Liabilities)-(Income-Expenses)
> >>
> >> Using your example this gives:
> >>
> >> 1m=(0-0)-(0-1m)
> >>
> >> Note that the "Equity" that must be used in this form of the equation is
> >> the balance in your Equity account, which will only change when you
> >> close the income and expense accounts (reduce them to zero by
> >> transferring the balances to the Equity account). When you do so, in
> >> this example, Equity would indeed become zero, but so would Expenses.
> >>
> >> Jim
> >>
> >>
> >>
> > Jim,
> > I think we all agree that this equation is the starting point (i.e., it
> is
> > correct):
> >  (Assets-Liabilities)=Equity+(Income-Expenses)
> >
> > Now let me derive the version I originally posted:
> >
> > 1. remove parens - they aren't needed:
> > Assets-Liabilities=Equity+Income-Expenses
> > 2. add Expenses to both sides:
> > Assets-Liabilities+Expenses=Equity+Income
> > 3. subtract Income from both sides:
> > Assets-Liabilities+Expenses-Income=Equity
> > 4. group for discussion purposes:
> > (Assets-Liabilities)+(Expenses-Income)=Equity
> >
> > That's what I posted in my original email. So far the replies have only
> > added to the confusion -- with the exception of Jeff's reply, which I
> think
> > is correct and which does help me understand what I was missing. But
> given
> > that all the other replies are raising doubts about my algebra, I remain
> > less than 100% sure...
> >
> > However, I cannot see any algebra mistake, so I think my original
> expression
> > is valid:
> >
> > (Assets - Liabilities) + (Expenses - Income) = Equity
> >
> > ...but I still think it defies common sense (and that is accentuated by
> the
> > replies which attempt to refute this formulation of the basic accounting
> > formula and which explain a version that I think is incorrect). I think
> > Jeff's answer explains it from an accounting viewpoint. However, I would
> > hope to see a consensus reached on the list or an authoritative reply to
> > remove my remaining doubts. (Or, if I am making an algebra mistake,
> kindly
> > point it out.)
>
> I think Jeff and James are right. Your algebra is correct and my
> equation was wrong. I have to admit, I'm a bit confused by the
> equation, as well.
>
> --
> Ryan
>

Ryan, thanks for your reply. We're one step closer to a consensus now. But
you said "Jeff and James are right." For the record, they are in
disagreement with each other as far as I can tell. I still think Jeff is
right. So let's see how this turns out when we hear back from them or
others. :)