Basic Accounting Concepts - what am I missing?

[Jim Smith]

On Sun, Jan 2, 2011 at 6:45 PM, Jim Smith <jimsmth761 at gmail.com> wrote:

> On Sun, Jan 2, 2011 at 6:02 PM, Mike or Penny Novack <
> stepbystepfarm at mtdata.com> wrote:
>
>>
>>  You are double-counting. Expenses and income are (at least in Gnucash)
>>> immediately posted into Assets or Liablilities. In traditional
>>> journal-oriented bookkeeping, the journal is posted into the General
>>> Ledger
>>> periodically, so that to obtain an intermediate picture, you have to
>>> consider the journal entries as well as the General Ledger.
>>>
>>>
>>>
>>
>>
>> GnuCash is standard journal + ledger accounting except that these steps of
>> first entering the transaction in the journal and then later posting into
>> the ledger has been automated. Since errors made while posting were one of
>> the headaches of old fashioned pen and ink on paper bookkeeping this
>> "autoposting" is wonderful.
>>
>> Normally we enter the transactions working from the ledger account of ANY
>> of the accounts affected. We get to specify the other account(s) and how
>> much split to each (if it is a split). GnuCash builds the corresponding
>> journal entry for us (you can ask to see the journal; one of the reports).
>>
>> The journal is the time ordered record of activity. The ledgers hold that
>> activity segregated into like types (and then within that ordered by time).
>> You could think of the whole thing as simply a pile of transactions (each
>> double entry grouped and ordered in different ways).
>>
>> BUT --- no, expenses and income are not "immediately posted into assets or
>> liabilities". That's not what "posting" means. Any transaction affecting an
>> account of type income (or expense) will also normally* be affecting an
>> account of type asset or type liability as the other side of the double
>> entry. All transactions add a net zero to the books (they remain in
>> balance).
>>
>> Michael
>>
>> * Conceivably could be equity on the other side of the transaction. For
>> example, if I paid an expense of my business using my PERSONAL check then I
>> have in effect "made an additional investment" in the business -- the
>> opposite of a "draw".
>>
>
> Michael,
> I'm glad to see you take an interest in this thread. Do you agree that the
> following equation is indeed correct?
>
> (Assets - Liabilities) + (Expenses - Income) = Equity
>
> I believe it is equivalent to
>
> Assets - Liabilities = Equity + (Income - Expenses)
>
> as posted here: http://code.gnucash.org/docs/guide/accts-concepts1.html
>
> If we confirm that the equation "(Assets - Liabilities) + (Expenses -
> Income) = Equity" is correct, what is the common sense explanation for why
> income negatively affects equity?
>
> Jeff explained some important points above and I assume he is totally
> correct. But he also said, "Accountants have a funny way with signs to
> make this all work out ("debit" and "credit") where some types of accounts
> are "backwards" from what an arguably rational person might first think." So
> do I just have to accept that some things are backwards, or is there a
> "common sense" explanation for why more income leads to less equity in this
> equation?
>
> Or is it that the equation is governed by rules other than purely
> mathematical ones? I think that's what Jeff and others hinted at. Are there
> rules (e.g. double entry) that restrict the way the equation can be used?
> Without these rules, clearly more income means less equity and that still
> strikes me as weird.
>
> EDIT/UPDATE: I reviewed the diagram at
> http://code.gnucash.org/docs/guide/accts-concepts1.html again. From the
> diagram, income contributes to equity. But I don't recognize the same
> relationship from the equation and the more I think about it, the more I
> believe this accounting equation is not a "real" mathematical equation so
> much as a shorthand for a whole set of other concepts (e.g., "accounting
> concepts" including double entry restrictions). It seems like the equation
> doesn't stand on its own. It only works if double entry rules restrict it's
> scope. Still confused...
>

In the event that no one wants to go into greater depth on this discussion,
I'll offer my summary thoughts:

I have come to understand the Accounting Equation as a function rather than
a mathematical equation. It is a function because of the restriction that
double entry is always required. It doesn't work as a purely mathematical
equation. Thinking of it as an equation leads to nonsensical results.

That's what I understand from the discussion so far. Thanks for the input.