The trouble with double-entry...

[Derrick Ashby]

Rod Engelsman wrote:

> accounting is that it doesn't have the mechanisms to accurately and 
> easily deal with certain real-life situations.  I know this is the 
> kind of statement that would make an accountant squeal, but it's the 
> truth.
>
> Let's take the whole issue of asset valuation, for instance. 
> Double-entry requires that any change in one account has to be 
> balanced by a change in another. So to reflect the fact that an asset 
> has changed value one has to make a corresponding entry somewhere 
> else. So if I buy 100 shares of XYZ stock and the price subsequently 
> doubles, where does that extra value come from? Is that an income? 
> Because you're worth more, but the only way to make that happen is to 
> have a higher income while the expenses stay the same. But that's not 
> real money, is it? You can't buy groceries with it or pay the rent. 
> And you don't pay taxes on it. And just the reverse if the price goes 
> down. Where did the money go? Does it wreck your budget?

Increases in asset valuations are handled without too much problem in 
double entry accounting.  I recently decided to add $50,000 to the 
notional value of my house.  That was a Debit ("Increase") in the 
Asset:Fixed Asset: House account, and a Credit in the Income:Capital 
Gains account.  No, it isn't real money. Thanks to the valuation on my 
house, the bottom line on the family combined balance sheet is in 7 
figures, but I don't feel particularly wealthy, but I don't see that as 
a problem.

gnucash adjusts the asset values of tradeable stocks according to the 
stock prices that are entered in the Price Editor.  These are 
theoretically balanced in the Balance Sheet as an unrealised gain.  I 
say "theoretically", because that only works until you sell some stocks, 
at which point the program seems to have trouble keeping track.  The 
fact that share prices fluctuate doesn't seem to me to invalidate the 
way that double entry accounting works.

>
> Another real-life situation: Suppose you strike ill and incur a large 
> medical bill. So large, in fact that you have to pay it over time. 
> Logically, that's a liability. So to create the liability you have to 
> incur a corresponding expense. Payments against the liability are 
> transfers that don't change your net worth. But medical expenses are 
> deductible. But you can only claim that part of the bill that you have 
> actually paid. So you're in a situation where it's damn difficult to 
> simultaneously track your net worth accurately (which is really the 
> whole point of traditional double-entry) and account for your 
> deductible expenses.


That's easy.  Any good or service that you receive now, but pay for 
later goes into Liabilities:Accounts Payable.  It's also entered as an 
Expense - say Expenses: Medical.  When you make a payment off the bill, 
the amount is deducted from the balance in Accounts Payable by being 
entered as a Debit on that account, and is deducted from your bank 
account (Credit side).  If you want to handle the tax deductability of 
the payment, you need to also enter the payment as a Credit to the 
Expenses: Medical account, and a Debit to another account, say Expenses: 
Deductable Medical.  This has the effect of transferring the amount from 
one Expense to another, and is therefore neutral to the balance sheet.

>
> The whole problem stems from the inability to distinguish between 
> "internal" and "external" liabilities. By that I mean internal 
> liabilities are things like loans and credit cards. While external 
> would be an outstanding bill -- an account payable, I guess. In the 
> example above, if you were to pay the medical bill with a credit card 
> or take out a bank loan, then you could easily and accurately account 
> for the expense for taxes.
>
> Now here's where I screw with 700 years of accounting tradition. I 
> think it's just wrong to equate an account -- real physical account 
> like a bank account -- with a conceptual entity like an expense 
> category. When I pay the rent each month I'm not writing a check to 
> "Rent", but rather to my landlord -- another real palpable entity. In 
> real accounting, who you pay the money to doesn't matter; it's little 
> more than a memo. It's confusing a who or where or what with a why.
>
> I have to get to class, but I'll have more on this later...
>
> Rod

In older style accounting there would normally be an account in the 
ledger for every entity you dealt with, but that seems to have gone out 
of style.  gnucash has its Customers and Vendors components that you can 
use.  I use the Vendors screens for bills that come in that don't need 
to be paid immediately.  You could do the same for your landlord.  I 
think the problem stems from the fact that you've been using MS Money 
for 15 years. :-)

Derrick