The words "Income" and "Expense" are beguilingly simple; everyone thinks they know what they mean; this usually is that When I spend something, this is an expense, and when I get money, this is an income.
This oversimplifies things somewhat; it is often a good-enough approximation when doing personal accounting, but when running a business, incomes and expenses often have be recognized as having occurred when some "critical event" takes place that may not perfectly correspond to "when cash comes in or goes out."
For instance, companies usually have to recognize income when the sale occurs. That may mean that I have to recognize a $100,000 sale at the moment I and the customer shake hands on the deal.
Since the money hasn't come in, the sale has to be estimated in other way; the way this is done is to accrue a sale at that time, and in making the transaction balance, rather than adding something in to cash, I'd add the $100,000 sale to Accounts Receivable.
In a double entry system, two kinds of accounts must be created: some of type "Income" and others of type "Expense." (There tend to be a lot more different kinds of expenses than there are of incomes.)
Income such as salary, wages, bank interest and stock dividends are then recorded as transfers from an income account to a bank (or, in general, some asset) account. Similarly, expenses are recorded as transfers from a credit card account (or, in general, a liability account).
Another way of describing the requirement for "double entry" is that when you receive an income, two things happen:
When, for instance, salary is deposited in a bank account, the bank account is credited, and the income account is debited, thus:
Account | Debit | Credit |
---|---|---|
Chequing Account | 1,600.00 | |
Salary | 1,600.00 |
This may be readily extended to a greater number of "split" items thus:
Account | Debit | Credit |
---|---|---|
Chequing Account | 1,300.00 | |
Income Taxes | 200.00 | |
Health Plan | 100.00 | |
Salary | 1,600.00 |
There may be a whole lot more than two entries in the transaction, but the total sum of the Debits, $1,600.00, still equals the total sum of the credits, $1,600.00.
If, as with GnuCash, everything is forced onto one column, so that debits are represented by positive values, and credits are represented by negative values, the income/expense accounts do a slightly non-intuitive thing and you see incomes as negative values. That appears contrary to intuition, but is nonetheless necessary in order for the double-entry bookkeeping identity to hold true.
Another way in which income and expense accounts are special is that their account totals do not directly appear on a balance sheet. A balance sheet shows "Net Worth": the sum of all assets minus all liabilities.
Income and expenses are neither assets nor liabilities, and so do not appear on the balance sheet. What appears on the balance sheet is their effects on equity.
There is a separate report, a "Profit and Loss" (P&L) report, to analyze income and expenses. The total profit (or loss) is calculated as total income less total expenses. In a nicely symmetrical fashion, since assets and liabilities are neither income or expenses, they correspondingly do not appear on a P&L statement.
Even though these accounts may be somewhat "special", you do not need to do anything particularly special to use income and expense accounts. GnuCash handles the values automatically, so that if you record properly the effects of the transactions on your bank account or credit card, the income/expense side of the transaction should also be handled correctly.
The time when things get "peculiar," and when you need to more deeply understand this, is when amounts are transferred between income/expense accounts. (The causes for such transfers tend to be somewhat peculiar, so it's pretty fair for this to be a pretty odd situation.)
To use an income/expense account, simply create one from the "New Account" dialogue window, and then be sure to transfer income/expenses to it as you record paychecks, interest, etc.
You will doubtless wish to create quite a number of income and expense accounts; it may be worth looking at the Sample Chart of Accounts for ideas.
This partitioning of incomes and expenses is likely to prove particularly useful for North Americans when income tax time rolls around.
If you have used other personal finance software, be aware that Quicken calls them "Categories."
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