[GNC] Contingency Funds was: Re: How to record Personal income tax ?

[David Cousens]

It is sometimes confusing to think of the double entry recording in accounts
as a transfer. There are circumstances where that is appropriate but in many
transactions you record it is not but the second account is usually referred
to as the "transfer" account in the Gnucash documentation.

Each month you credit the Liability:Tax by $100 and debit the Expense:tax
account by $100 which is recording that you estimate you will be obligated
to pay that amount of tax on the income from that month at the end of the
year. This is usually only an estimate because other factors may affect the
income tax the government will actaully require you to pay. So by the end of
the year your liability and expense accounts for tax will each have
increased from the initial balance by $1200. If the initial balance for the
year was $0 then it will be $1200.

At the end of the year I am assuming you have some sort  procedure where you
file a document with the government setting out your income for the year and
any other factors which may affect your income tax and they will then
provide you with an assessment of how much tax you actually owe them and for
the purposes of discussion this is $1000.

At this point your actual liability is no longer what you estimated from
your income during the year at $1200 but is only $1000. This requires the
Liability:Tax  and Expense:Tax accounts to be adjusted so the balances are
only $1000. To do this you create an adjustment transaction to debit the
Liability:Tax account by $200 and credit the Expense:Tax by $200. Now the
lIability:Tax account balance indicates what you actually owe the government
and the Expense:Tax account will indicate what you have paid in tax once you
pay the tax to the government.

When you pay the government, you no longer have an obligation to pay them
tax so the Liability:Tax is reduced from $1000 to $0 by a debit for $1000
and your check account balance is reduced by a credit to it of $1000. 

Because GnuCash and accounting generally uses a double entry system each of
the above transaction debits one account by the transaction amount and
credits another account by the same amount. 

(More complex transactions affecting  more than two accounts are also
possible in accounting and in these the sum of the debits to accounts is
equal to the sum of the credit to accounts in the transaction but they are
not needed to explain this situation.)

This is one way of doing the book entries which is slightly simplified and
OK if you are using accrual accounting. Another way which is more
appropriate for cash accounting is not to use the Expense:Tax account to
record the tax you estimate yo owe each month but to use an account under
Equity so the monthly tranasaction becomes

                                                       Dr             Cr
Liability:Tax                                                      100
Equity:TaxProvision                           100

At the endof the year each of these accounts ends up with the $1200 balance
as before. Again when you receive an assessment form the government
indicating that you actually only have to pay $1000 in tax, you have to
adjust these account balances in the same manner as the last example.
                                                       Dr             Cr
Liability:Tax                                      200
Equity:TaxProvision                                          200

and when you pay the tax you record it with entries like this:
                                                        Dr            Cr
Asset:Bank:Checking                                       1000
Liability:Tax                                     1000
and                                                    Dr           Cr
Equity:TaxProvision                                          1000
Expense:Tax                                    1000

The difference is that you do not record the tax as an Expense in cash
accounting until you actually pay the money to the government.

David



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David Cousens
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