Accounting Equation
Doug Laidlaw
laidlaws at hotkey.net.au
Sat Jun 30 02:41:03 EDT 2007
On Sat, 30 Jun 2007 03:54:54 pm lingwitt at bellsouth.net wrote:
> Hello,
>
> I don't have any credentials and my arithmetic is terrible,
> but it seems to me like the documentation's development
> of the accounting equation is completely wrong.
>
> This makes sense:
>
> Assets - Liabilities = Equity
>
> But then it says:
>
> "Furthermore, you can increase your equity through
> income, and decrease equity through expenses."
>
> So for income:
>
> EquityWithIncomeAndExpenses = Equity + Income - Expenses
>
> or
>
> EquityWithIncomeAndExpenses = Assets - Liabilities + Income - Expenses
>
> If we just refer to EquityWithIncomeAndExpenses as Equity, then:
>
> Equity = Assets - Liabilities + Income - Expenses
>
> or
>
> Assets - Liabilities = Equity - (Income - Expenses)
>
> but the docs say:
>
> Assets - Liabilities = Equity + (Income - Expenses)
>
> That is, the docs say:
>
> (Assets - Income) - (Liabilities - Expenses) = Equity
>
> and I say this:
>
> (Assets + Income) - (Liabilities + Expenses) = Equity
>
> Clearly the latter is correct.
>
> Why not dispel with Income and Expenses anyway and just
> call them Assets and Liabilities?
>
> Please correct me (I'm serious).
> _______________________________________________
> gnucash-user mailing list
> gnucash-user at gnucash.org
> https://lists.gnucash.org/mailman/listinfo/gnucash-user
> -----
> Please remember to CC this list on all your replies.
> You can do this by using Reply-To-List or Reply-All.
Assets and liabilities remain fairly constant, income and expenses are the
things that increase or decrease those.
Your equation
Equity = Assets - Liabilities + Income - Expenses
is accurate, but doesn't get the point.
If your assets are greater than your liabilities, you are solvent, otherwise
you are insolvent. i.e. your equity is negative.
If your expenses are greater than your income, you may be solvent now, but
eventually you won't be. That is the essential difference.
To take an example with figures (and like all these examples, no attempt to
keep them realistic):
Suppose that you have a bank account -an asset of $1 000.00 and a debt you
owe - a liability - of $200. Then your equity or capital is $800.
If you receive pay of $500 (Income) and pay a power bill (expense) of $150,
you have $350 left over. Whether it is in your bank account or your pocket,
I will assume that it is in the bank.
So you now have an asset - the bank account - worth $1 350
Your liability is unchanged at $200.00
Your equity is the difference, now $1 150.00
If you now pay off the debt, your bank account reduces to $1 150,
but you have no liabilities. Your equity is unchanged at $1 150.
In financial reports at the end of the year, it is put:
Assets 1000
Liabilities 200
-------
Equity 800
Income 500
Expenses 150
--------
Net profit 350
-----------
New equity 1 150
HTH,
Doug.
--
If you don't have a dream,
How are you going to have a dream come true?
- Oscar Hammerstein II.
More information about the gnucash-user
mailing list