# Basic Accounting Concepts - what am I missing?

Ryan Flegel rflegel at gmail.com
Sun Jan 2 12:40:13 EST 2011

```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
```