Basic Accounting Concepts - what am I missing?
Mike or Penny Novack
stepbystepfarm at mtdata.com
Mon Jan 3 08:44:23 EST 2011
This is really going to be easier if we start from the basics (and the
way this is usually taught). I believe a good deal of the trouble people
are having in seeing how this works is not understanding that the
balances of some sorts of ledger accounts are intrinsicly the opposite
sign of other -- the usual state of their balances. Debits and credits.
Forget subtraction. The whole point is that the early accountants
decided that it would be less error prone if records were kept so that
the ONLY arithmetic operation was addition. That would eliminate the
possibility of an error from adding when one should have subtracted or
vice versa. Also keep in mind that there were other important
considerations. There was no automated mechanism for maintaining a
running balance, no automated report generators, and errors could always
be made in entering or copying numbers (so you would want a way of
noting "up to this point no errors" so searching for an error didn't
have to start from the beginning of the books each time).
That's why the fundamental equation is conventionally addressed as:
Assets = Liabilities + Equity
Which since income and expense accounts are temporary accounts of
fundamental type equity (delaying their affect on equity so their totals
can be seen)
Assets = Liabilities + Equity + (Income - Expenses)
NOT strictly speaking algebra. In terms of algebra might be seen as
Assets + Liabilities + Equity + Income + Expenses = 0
(Assets and Expenses normally have debit balances; Liabilities, Equity,
and Income credit balances -- the net sum of the books is always zero if
they are in balance)
What "double entry" means is that EVERY transaction you enter will
change debits and credits by the same amount (and thus add nothing to
the net sum of the books; if in balance before the transaction still in
Accounts never have a negative balance which means no need to keep track
of sign or the risk of error from losing a sign. Instead the balance
would be on the opposite side (debit or credit) from where you would
ordinarily expect it to be.
Does this make more sense now? The system was designed to make errors
less likely and easier to find when they did occur.
The usual way this is taught is by "T diagrams" for the accounts. I
seriously suggest that if you don't know standard accounting/bookkeeping
you get a text teaching "accounting 101" as this will show these to you
and make clear what is going on. Some of the questions we have here are
of the nature "how do I use GnuCash to do thus and so?" (which I
understand how to do in some other application or pen and paper) and
others are more along the lines of "how do I do thus and so?" (at the
level where you would have the SAME question doing it pen and paper; not
really a Gnucash question even though asked in the context of Gnucash).
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