Basic Accounting Concepts - what am I missing?

Jim Smith jimsmth761 at gmail.com
Sun Jan 2 12:21:31 EST 2011


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.)


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