Accounts
This chapter will discuss some useful concepts for organizing your
accounts. Since &app; does not impose any specific account tree layout,
you are free to design your account structure in any manner you wish.
However, there are a few basic accounting concepts which you will probably
want to follow when designing your accounts to maximize their
utility.
Basic Accounting Concepts
As we saw in the previous chapter, accounting is based on 5 basic
account types: Assets,
Liabilities, Equity,
Income and Expenses. We will now
expand on our understanding of these account types, and show how they are
represented in &app;. But first, let's divide them into 2 groups, the
balance sheet accounts and the income and expense accounts.
Let's have a quick look at the Accounting Equation (Assets
- Liabilities = Equity + (Income - Expenses)) again as a
reminder, before we go deeper into each account type.
The basic accounts relationships
A graphical view of the relationship between the 5 basic
accounts. Net worth (equity) increases through income and decreases
through expenses. The arrows represent the movement of value.
Balance Sheet Accounts
The three so-called Balance Sheet Accounts
are Assets, Liabilities, and
Equity. Balance Sheet Accounts are used to track
the changes in value of things you own or owe.
Assets is the group of things that you own.
Your assets could include a car, cash, a house, stocks, or anything else
that has convertible value. Convertible value means that theoretically
you could sell the item for cash.
Liabilities is the group of things on which
you owe money. Your liabilities could include a car loan, a student
loan, a mortgage, your investment margin account, or anything else which
you must pay back at some time.
Equity is the same as "net worth." It
represents what is left over after you subtract your liabilities from
your assets. It can be thought of as the portion of your assets that you
own outright, without any debt.
Income and Expense Accounts
The two Income and Expense Accounts are used
to increase or decrease the value of your accounts. Thus, while the
balance sheet accounts simply track the value of
the things you own or owe, income and expense accounts allow you to
change the value of these accounts.
Income is the payment you receive for your
time, services you provide, or the use of your money. When you receive a
paycheck, for example, that check is a payment for labor you provided to
an employer. Other examples of income include commissions, tips,
dividend income from stocks, and interest income from bank accounts.
Income will always increase the value of your Assets and thus your
Equity.
Expenses refer to money you spend to purchase
goods or services provided by someone else. Examples of expenses are a
meal at a restaurant, rent, groceries, gas for your car, or tickets to
see a play. Expenses will always decrease your Equity. If you pay for
the expense immediately, you will decrease your Assets, whereas if you
pay for the expense on credit you increase your Liabilities.
&app; Accounts
This section will show how the &app; definition of an account fits
into the view of the 5 basic accounting types.
But first, let's begin with a definition of an
account in &app;. A &app;
account is an entity which contains other
sub-accounts, or that contains transactions. Since an
account can contain other accounts, you often see account
trees in &app;, in which logically associated accounts reside
within a common parent account.
A &app; account must have a unique name (that you assign) and one
of the predefined &app; "account types". There are a total of 12 account
types in &app;. These 12 account types are based on the 5 basic
accounting types; the reason there are more &app; account types than
basic accounting types is that this allows &app; to perform specialized
tracking and handling of certain accounts. There are 6 asset accounts
(Cash, Bank,
Stock, Mutual Fund,
Accounts Receivable, and Other Assets
), 3 liability accounts (Credit Card,
Accounts Payable, and Liability,
), 1 equity account (Equity), 1 income account
(Income), and 1 expense account
(Expense).
Please Note: For all &app; asset accounts, a
debit (left-column value entry) increases the account
balance and a credit (right-column value entry)
decreases the balance.
These &app; account types are presented in more detail
below.
Balance Sheet Accounts
The first balance sheet account we will examine is
Assets, which, as you remember from the previous
section, refers to things you own.
To help you organize your asset accounts and to simplify
transaction entry, &app; supports several types of asset
accounts:
Cash Use this account to track the money
you have on hand, in your wallet, in your piggy bank, under your
mattress, or wherever you choose to keep it handy. This is the most
liquid, or easily traded, type of asset.
Bank This account is used to track your
cash balance that you keep in institutions such as banks, credit
unions, savings and loan, or brokerage firms - wherever someone else
safeguards your money. This is the second most
liquid type of account, because you can easily
convert it to cash on hand.
Stock Track your individual stocks and
bonds using this type of account. The stock account's register
provides extra columns for entering number of shares and price of
your investment. With these types of assets, you may not be able to
easily convert them to cash unless you can find a buyer, and you are
not guaranteed to get the same amount of cash you paid for
them.
Mutual Fund This is similar to the stock
account, except that it is used to track funds. Its account register
provides the same extra columns for entering share and price
information. Funds represent ownership shares of a variety of
investments, and like stocks they do not offer any guaranteed cash
value.
Accounts Receivable (A/Receivable) This
is typically a business use only account in which you place
outstanding debts owed to you. It is considered an asset because you
should be able to count on these funds arriving.
Other Assets No matter how diverse they
are, GnuCash handles many other situations easily. The group
category, "Other Assets", covers all assets not listed above.
Accounts are repositories of information used to track or record
the kinds of actions that occur related to the purpose for which the
account is established.
For businesses, activities being tracked and reported are
frequently subdivided more finely than what has been considered thus
far. For a more developed treatment of the possibilities, please read
the descriptions presented in
of this Guide.
For personal finances a person can follow the business groupings
or not, as they seem useful to the activities the person is tracking
and to the kind of reporting that person needs to have to manage his
financial assets. For additional information, consult
of this Guide.
The second balance sheet account is
Liabilities, which as you recall, refers to what
you owe, money you have borrowed and are obligated to pay back some day.
These represent the rights of your lenders to obtain repayment from you.
Tracking the liability balances lets you know how much debt you have at
a given point in time.
&app; offers three liability account types:
Credit Card Use this to track your credit
card receipts and reconcile your credit card statements. Credit
cards represent a short-term loan that you are obligated to repay to
the credit card company. This type of account can also be used for
other short-term loans such as a line of credit from your
bank.
Accounts Payable (A/Payable) This is
typically a business use only account in which you place bills you
have yet to pay.
Liability Use this type of account for
all other loans, generally larger long-term loans such as a mortgage
or vehicle loan. This account can help you keep track of how much
you owe and how much you have already repaid.
Liabilities in accounting act in an opposite manner from assets:
credits (right-column value entries) increase
liability account balances and debits
(left-column value entries) decrease them. (See note later in this
chapter)
The final balance sheet account is Equity,
which is synonymous with "net worth". It represents what is left over
after you subtract your liabilities from your assets, so it is the
portion of your assets that you own outright, without any debt. In
&app;, use this type of account as the source of your opening bank
balances, because these balances represent your beginning net
worth.
There is only a single &app; equity account, called naturally
enough, Equity.
In equity accounts, credits increase account balances and debits
decrease them. (See note later in this chapter)
The accounting equation that links balance-sheet accounts is
Assets = Liabilities + Equity or rearranged Assets - Liabilities =
Equity. So, in common terms, the things you own
minus the things you owe equals your
net worth.
Income and Expense Accounts
Income is the payment you receive for your
time, services you provide, or the use of your money. In &app;, use an
Income type account to track these.
Credits increase income account balances and debits decrease
them. As described in ,
credits represent money transferred
from an account. So in these special income
accounts, when you transfer money from (credit)
the income account to another account, the balance of the income
account increases. For example, when you deposit
a paycheck and record the transaction as a transfer from an income
account to a bank account, the balances of both accounts
increase.
Expenses refer to money you spend to purchase
goods or services provided by someone else. In &app;, use an
Expense type account to track your expenses.
Debits increase expense account balances and credits decrease
them. (See note later in this chapter.)
When you subtract total expenses from total income for a time
period, you get net income. This net income is then added to the
balance sheet as retained earnings, which is a type of
Equity account.
Below are the standard Income and
Expense accounts after selecting Common
Accounts in the Druid for creating a new Account Hierarchy
(File -> New -> New Account Hierarchy).
Default income accounts
This image shows the standard income
accounts
Some default expense accounts
This image shows some standard expense
accounts
More on Debits and Credits
Remember the terms debit and credit discussed in
?
Contrary to popular belief and even some dictionary definitions,
accounting debits and credits do not mean decrease and increase. The
only constant definition of debits and credits is that debits are
left-column entries and credits are right-column entries. In fact,
debits and credits each increase certain types of accounts and
decrease others. In asset and expense type accounts, debits increase
the balance and credits decrease the balance. In liability, equity and
income type accounts, credits increase the balance and debits decrease
the balance.
For example, debits increase your bank
account balance and credits decrease your bank
account balance. Wait a minute, you might say, a
debit card decreases the
balance in my checking account, because I take money out of it. And
when the bank gives me money back on something, they
credit my account. So why is this reversed in
accounting?
Banks report transactions from their
perspective, not yours. Their perspective is exactly opposite to
yours. To you, your bank account represents an asset, something you
own. To the bank, your bank account represents a loan, or liability,
because they owe you that money. As explained in this chapter, asset
and liability accounts are exact opposites in the way they behave. In
a liability account, debits decrease the balance
and credits increase the balance.
When you take money out of your bank account, the balance in
your account decreases. To you, this is a decrease in an asset, so you
credit your bank account. To the bank, this is a
decrease in a liability, so they debit your bank
account.
Putting It All Together
Let's go through the process of building a common personal finance
chart of accounts using the information we have
learned from this chapter. A chart of accounts is simply a new &app;
file in which you group your accounts to track your finances. In building
this chart of accounts, the first task is to divide the items you want to
track into the basic account types of accounting. This is fairly simple,
let's go through an example.
Simple Example
Let us assume you have a checking and a savings account at a bank,
and are employed and thus receive a paycheck. You have a credit card
(Visa), and you pay monthly utilities in the form of rent, phone, and
electricity. Naturally, you also need to buy groceries. For now, we will
not worry about how much money you have in the bank, how much you owe on
the credit card, etc. We want to simply build the framework for this
chart of accounts.
Your assets would be the bank savings and
checking account. Your liabilities are the credit
card. Your Equity would be the starting values of
your bank accounts and credit card (we do not have those amounts yet,
but we know they exist). You have income in the
form of a salary, and expenses in the form of
groceries, rent, electricity, phone, and taxes (Federal, Social
Security, Medicare) on your salary.
The Basic Top Level Accounts
Now, you must decide how you want to group these accounts. Most
likely, you want your assets grouped together, your liabilities grouped
together, your Equity grouped together, your income grouped together,
and your expenses grouped together. This is the most common way of
building a &app; chart of accounts, and it is highly recommended that
you always begin this way.
Start with a clean &app; file (do not select any predefined
accounts) and build this basic starting account structure
(File -> New
Account...).
Account name Assets (account type
Assets, parent account New top level
account)
Creating an Assets account
This image shows the dialog to create an asset
account
Account name Liabilities (account type
Liabilities, parent account New top
level account)
Account name Equity (account type
Equity, parent account New top level
account)
Account name Income (account type
Income, parent account New top level
account)
Account name Expenses (account type
Expenses, parent account New top
level account)
When you have created the top-level accounts, the main Account page
in &app; should look like below
The Basic Top-level Accounts
This image shows the basic top-level accounts.
Making Sub-Accounts
You can now add to this basic top-level tree structure by inserting
some real transaction-holding sub-accounts. Notice that the tax accounts
are placed within a sub-account named "Taxes". You can make sub-accounts
within sub-accounts. This is typically done with a group of related
accounts (such as tax accounts in this example).
Account name Checking (account type
Bank, parent account
Asset)
Account name Savings (account type
Bank, parent account
Asset)
Account name Visa (account type
Credit Card, parent account
Liabilities)
Account name Salary (account type
Income, parent account
Income)
Account name Phone (account type
Expenses, parent account
Expenses)
Account name Electricity (account type
Expenses, parent account
Expenses)
Account name Rent (account type
Expenses, parent account
Expenses)
Account name Groceries (account type
Expenses, parent account
Expenses)
Account name Taxes (account type
Expenses, parent account
Expenses)
Account name Federal (account type
Expenses, parent account
Expenses:Taxes)
Account name Social Security (account
type Expenses, parent account
Expenses:Taxes)
Account name Medicare (account type
Expenses, parent account
Expenses:Taxes)
Account name Opening Balance (account
type Equity, parent account
Equity)
After you have created these additional sub-accounts, the end
result should look like below
The Basic Chart of Accounts
This image shows a simple chart of accounts.
Save this chart of accounts with the name
gcashdata_3, as well as gcashdata_3emptyAccts,
as we will continue to use them in the later chapters.
You have now created a chart of accounts to track a simple
household budget. With this basic framework in place, we can now begin
to populate the accounts with transactions. The next chapter will cover
this subject in greater detail.