[GNC] General accounting question about Assets = Liabilities + Equity

[Adrien Monteleone]

Brandon,

Continuing on what David noted...

Income and Expenses are traditionally considered temporary accounts that are ‘closed’ to Equity at the end of an accounting period, generally, one year.

Therefore, the expanded equation would be:

Assets = Liabilities + (Income - Expenses)

After the first period closing, you’d have:

Assets = Liabilities + (Income - Expenses) + Retained Earnings

Where ‘Retained Earnings’ are the result of previous periods where Income and Expenses were closed to Equity. (it is technically a sub-account of Equity. There can be other equity sub-accounts, but they generally come from Income, Expenses, or Retained Earnings.)

With the advent of computers, the physical limitations of pen and paper no longer require the ‘closing of the books’ and thus Income and Expenses can roll over forever. If you need to do a traditional calculation of Retained Earnings, a report can handle that for you without a specific special account in your tree. (You can still perform this book closing with computers, but it is not necessary unless the software forces you to. GnuCash does not, and generally does not recommend it.)

The signs that throw people off are because they are there when all of the terms are on one side of the equation.

If you were to re-write it like so:

Assets - Liabilities - Equity - Income + Expenses = 0

then you’ll see why Equity is listed as a negative. It isn’t a double negative, the sign doesn’t belong to the value itself. But it is stored that way, because it makes the equation simpler to write (in code) as all addition operations:

Assets + (-Liabilities) + (-Equity) + (-Income) + Expenses = 0

Notice that all of the ‘positive’ terms are normally debit accounts. (a debit will increase them) And that the ’negative’ terms are all credit accounts. (a credit will increase them)

It is this mess why some people recommend to turn on the feature to ‘reverse balance’ accounts for the credit accounts. (for display purposes only, not internal calculations) That way, Income looks positive, as does Equity. Liabilities will also look positive with that setting, which is easy to see the larger it is, the more you owe. (you already know it is a subtraction from net worth, because of its nature) This also allows for easy spotting of errors like reversed debit/credit entries. If an account has a negative balance, something is wrong. (unless it is a special ‘contra-balanced’ account, in which case a negative balance is a visual clue that the balance is ’normal’)

Using positive values/signs for credit accounts also makes the traditional Accounting Equation make sense. The negative signs were only introduced to perform the "all addition" form of the equation.

Regards,
Adrien



> On Jan 14, 2020 w3d14, at 11:38 AM, Brandon Captain <caibbor at gmail.com> wrote:
> 
> Hello,
> 
> I have a rather general accounting question in regards to the Assets =
> Liabilities + Equity formula, and how it relates to the other GNUCash
> default accounts like Income and expenses. Those accounts are neither
> assets, liabilities, nor equity. So I'm not sure how to factor them in -
> unless Income is an asset? Then why isn't it listed as a sub-account of
> Assets?
> 
> Take the following accounts for example:
> 
> assets (debit) 209.01
> income (credit) 22975.27
> liabilities (credit) 1497.72
> expenses (debit) 5445.24
> equity (credit): -18818.74
> 
> (Equity breaks down as 3863.47 in contributions and -22682.21 in draws)
> 
> If you add all the debits together, it comes out to 5654.25. Likewise, if
> you add all the credits together, you get the same figure of 5654.25 (which
> as I understand means that it balances).
> 
> But assets = liabilities + equity would be ( 209.01 = 1497.72 + -18818.74 )
> which just... doesn't work. Not without the other accounts in the figure,
> and not without reversing the signs since 1497.72 is actually -1497.72 in
> reality, and so forth.
> 
> I'd appreciate any explanation on this. I've Googled and researched a bit
> but there's something I'm still not quite understanding.
> 
> Thank you