Basic Accounting Concepts - what am I missing?

[J. Alex Aycinena]

Jim - see comments below:

>
> ---------- Forwarded message ----------
> From: Jim Smith <jimsmth761 at gmail.com>
> To: gnucash-user at gnucash.org
> Date: Sun, 2 Jan 2011 18:45:16 -0500
> Subject: RE: Basic Accounting Concepts - what am I missing?
> 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?
>

It is right here where I think you get into trouble - you seem to
think that income can change all by itself and that that should affect
equity, but it can't (remember - double entry). If in this equation,
income goes up, let's say that the expenses needed to generate that
income went up the same amount so that 'net income' (the difference
between expenses and income) is zero - in this case equity stays the
same.

Now, alternatively, let's say that you received a gift of cash (income
with no expenses) and deposited the cash in your checking account.
Your assets increase the same amount as your income amount and the
equation stays in balance. Now, how much has your equity changed?
Thinking from the standpoint of this one transaction, your beginning
equity is changed by the difference between  income and expenses
(e.g., for the accounting period in question, ending equity =
beginning equity + income - expenses, or equity + amount of gift -
zero expenses) or in this case the amount of the gift which also
equals the change in the difference between assets and liabilities
from the beginning of the accounting period to the end of the
accounting period (lasting just one transaction in this example) which
is your increase in your checking account of the amount of the gift.

For an accounting period that involves many transactions, the same
principal applies.

> 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...
>
>