Basic Accounting: Short Term vs. Long Term Expenses

[David Harrison]

On 9/27/05, Greg Novak <novak at ucolick.org> wrote:
>
> I'm looking for suggestions about how to solve a basic accounting
> issue--perhaps there's a standard solution, but my attempts so far have
> failed to produce a silver bullet.
>
> I simply need to know if I'm living beyond my means by keeping day-to-day
> cash flow rigidly separate from infrequent, large bills and purchases.
> Here I define "short term" as being entirely contained within one month
> (the frequency with which I balance my checkbook). These things happen
> often enough that one month is fair average of the expense. "Long term"
> means that the transaction extends over several months. It could be
> semi-annual car insurance payments or the process of saving up for several
> months with the goal of buying, say, a bike.



The answer for the car insurance (and any other bill which you pay in
advance) is to set up the initial transaction as a prepaid expense, and
expense the monthly portion each month. This would look like:

Initial payment of car insurance:
Assets: Chequing 1,200 (Cr)
Assets: Prepaid expense 1,200 (Dr)

Entry each month to expense that months expense (assumed 1,200 is for 12
months):
Assets: Prepaid expense 100 (Cr)
Expenses: Car insurance 100 (Dr)

What I've done for some time now is balance my checking account to exactly
> 1000 at the end of every month, transferring the excess/shortfall to/from
> my savings account. That works pretty well, but fails in two cases:
> 1) Say I've saved up $1000 to buy a new bike--I can't spend the money
> directly out of my savings account, so I have to transfer it to the
> checking account and then spend it. This makes the account look funny for
> the month because I've spent so much more than the "nominal" amount. 2)
> Credit card purchases. It's easy to rack up debt and still (incorrectly)
> feel good about myself because I don't realize that I've overspent until
> the bill comes.
>
> I fixed problem #1 by getting a savings account that allows me to write
> checks. Then I can spend saved money straight from the savings account.


Sounds like this is ok, then?

Problem #2 is still giving me trouble. I can see three solutions:
> 1) Cut up the credit card
> 2) Keep a separate tree of expense accounts for "day-to-day expenses" and
> "long term expenses." Then I could infalliably see if I've spent too much
> on day-to-day expenses in a given month by checking the expense accounts
> rather than the asset/liability accounts. However, this is horrendously
> inelegant.
> 3) Group asset/liability accounts into "Day-to-day cash flow" and "Long
> term cash flow." That is, the account tree would look like:
>
> --Short Term
> ----Checking
> ----Cash
> ----Credit Card
> --Long Term
> ----Savings
>
> This would go against the seemingly near universal practice of grouping
> accounts by asset/liability. However, it would have the nice effect that
> credit card purchases couldn't sneak in and wreck the books. The down
> side to this scheme is that it may clash with the physical bank accounts.
> Ie, I couldn't use the _same_ credit card for both short and long term
> purchases.


Do you have a liability account set up for your credit card? When you incur
and expense on the credit card you enter it as:

Liabilities:Credit Card 100 (Cr)
Expenses: Whatever 100 (Dr)

Then when you pay the credit card, you enter:

Assets:Bank account 100 (Cr)
Liabilities:Credit card 100 (Dr)

Thoughts and suggestions are welcome, up to and including "You should just
> do X, that's what everyone does and it works fine."
>
> Thanks a bunch,
> Greg
>

Hope this helps

--
David Harrison, BAccS, CGA
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