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A New Domestic Accounting Model based on Domestic Well-Being
Rationale and Technical Introduction
John M PASSMORE
[Also have a look at the
General Introduction]
Other introductory articles on Domestic Well-Being
Accounting (DWBA) have hinted about some of the new ideas upon which
this new domestic accounting model is based. In this more
technical introduction, the rationale, ideas and concepts are outlined
in more detail, based on the coverage provided in a new book ‘Accounting
for a Better Life’ (see
www.dwba.co.uk
).
This article is not a primer on accounting theory but some background is
provided to help readers who may be unfamiliar with accounting and its
terminology, to get a feel for what these new ideas are all about.
Accounts
At its simplest, an account is just a list of transactions relating to some
area of financial activity or interest. The most familiar form of
account is the bank statement that customers periodically receive from
their bank. The account for their current or checking account
shows the previous balance, all the increases and decreases that have
happened over some period, together with a closing balance. In the
old days of hand written accounts, that was all you saw; now with
computerised support, you will usually also see a running balance
showing the changing sub-total after each transaction, where the effect
of all the previous transactions have been taken into account.
Where you might have one or more savings accounts, you will appreciate
that these funds are kept in separate accounts and customers will be
used to seeing separate statements for each of their accounts or areas
of interest.
The first important thing to appreciate is that accounts are for
accumulating information about value. We are so used to bank and
credit card accounts which are all about currency that people sometimes
do not realise that accounts are equally useful for accumulating
transaction details relating to, for example, our home, our car(s) – one
account for each car - our investments, etc. Although the amounts
entered in each of these accounts will be currency amounts, the object
being referred to will not always relate to a stack of cash but the
value of that house or car for example, in terms of some currency.
Accounts will usually have two columns, one for increasing (+) amounts
and the other for decreasing (-) amounts.
The next important concept is to appreciate that there are two distinct,
overarching types of accounts that we can use in our sets or
books of accounts. One is called an asset type account and the other is
a liability type account.
The asset type account as its name infers, typically relates to
storing transactions for assets such as bank accounts, houses, cars,
etc. The idea behind it is that positive amounts entered into the
+ column of an asset account signify increasing value; so £500 entered
into the + column of an asset account implies an increase in value of
£500, in relation to whatever purpose the account is being used for,
usually evident from the name of the account. However accountants
will also have in their business accounts, what I call working accounts
for home accounting, as other accounts of the asset type which
are not strictly for an asset like a car or a home. Examples
include accounts for asset acquisitions and for depreciation.
That other overall type of account is a liability account. It is
used for accumulating debts and/or liability. Now we have the
reverse concept in that increasing amounts e.g. £300 in the +
column of these
types of accounts imply more debt or more liability, whilst a
decrease of £200 represents less of a debt. You might think more debt
means less value but it all depends on the purpose for which a liability
account is being used. Again, accountants mostly use liability
type
accounts for holding true debt amounts but again, have a need for other
accounts of the liability type to mediate certain transactions.
I refer to these as working accounts in home accounting and they do not
relate to any true debts of a person or household; examples of these are
for accumulating temporary information about asset acquisitions and
growth in the value of a home. Here are examples of an asset and a
liability account in MS Money.
From the home accountant’s perspective I will mention here that from the
technical words that business accountants use, which can make it
somewhat confusing for the layman, there are words that everyone has
heard of – such as debit and credit – which relate specifically to
increases and decreases in relation to these two account types of
asset and liability accounts. It helps to understand these but as
has been pointed out in the general introduction, DWBA accounting
provides considerable attention to simplification and minimising the
need for accountant’s terminology; and there is more on this towards the
end of this article. Another area for confusion here relates to
the names for column headings used in the different software packages
available to support accounting; in business, the convention is that
debits (the + column for asset accounts and the - column for liability
accounts) are traditionally in the left-hand column of each account,
with the credits on the right (the - column of asset accounts and the +
column of liability accounts. This convention is not always
adhered to in some software packages, together with not always using the
headings, debit and credit.
Double Entry and the Accounting Equation
The last bit of theory to mention which is important because it
lies at the heart of DWBA accounting is so-called, double entry. This
concept appears confusing to people because it has two slightly
different aspects. First, it is an accounting concept which
relates to an approach for taking into account (there’s an appropriate
phrase!) all the financial aspects of some financial entity. In
business where double entry is nearly always used, an entity might be a
department or a division, a sole-trader or even a whole plc. For
the domestic accounting environment, such an entity would most often be
an individual or a household. The point is that the accounts
supporting any of these entities consider or model the totality of the
financial aspects of the entity. As such, the accounts will be
able to capture and disclose or make visible, both the static and
dynamic aspects of the entity finances; and we will look at these
shortly. The practical effect is that a set of double entry
accounts (the books) requires an account to store the total financial
value of the entity as well as usually, some accounts for accumulating
periodic changes in terms of increases and decreases to this overall
value. The result is what is termed a balanced set of accounts,
related to an ‘accounting equation’.
The other common use of the word double entry is related to the
bookkeeping techniques for implementing this form of accounting which,
as we shall now see, requires two (double) entries in the accounts for
each new transaction, in order to maintain the required balance.
What do we mean by balance? Well balance is the key to double
entry and it comes from balances in accounts, as maybe related in some
way in this equation – the so called accounting equation. If you
can accept that the balances of all the accounts representing the
finances of an entity must somehow be related, we know from schooldays
that related numbers is what equations are all about! If we had 20
numbers representing the 20 balances of these required accounts, we
should be able to relate these 20 numbers meaningfully in an equation in
some way. Let’s now approach this issue logically from the
beginning to talk our way through to deriving the equations.
If we consider a household, it might consist of a collection of assets –
a home, a car, three investments and a consolidated bunch of unspecified
appliances. We could set up 6 accounts to represent all these
assets and assuming there were no liabilities of the personal debt sort
– an unlikely assumption - we could say that our domestic wealth equals
the sum of the balances of those 6 asset accounts. Here is a
statement, which is not yet a true equation:
The sum of all Asset a/c balances = our Domestic Wealth
Now if we had some debts, perhaps a mortgage on the house and a loan for
the car, we could set up two more accounts (of the liability type)
to hold these two debt amounts.
Now, since we owe two amounts for these debts to some financial
organisations, we have to earmark the appropriate amounts to be repaid
from the value of our assets, in order to derive the changed new value
of our domestic wealth, so we can show this in another statement:
All Asset a/c balances - All Liability a/c balances (of the
debt type) = our Domestic Wealth
The crucial point about the double entry system which requires us to
take into account all aspects of our financial situation, implies that
we need to setup an additional account in order to store the amount of
our changing domestic worth. We call it a Domestic Wealth account.
Now, instead of a statement, we have an equation which is balanced:
All Asset a/c bals - All Liability a/c bals (of the debt
type) = Domestic Wealth a/c bal
The next issue is what type of account do we need to hold the
domestic wealth – asset or liability?
When you think about it, the amount of the domestic wealth represented
by the assets less the debts is owed to the eventual beneficiaries of
the household or individual’s estate. The executors have to pay
off the debts from the assets and what is left, the Domestic Wealth will
be shared out amongst the beneficiaries - so the domestic wealth is a
sort of liability from the viewpoint of the entity represented by the
accounts. It is owed to the beneficiaries and therefore should
logically, reside in a liability account.
Now we can tidy the equation up by putting all the asset type
accounts on one side with all the liability type accounts on the
other; the result is with appropriate changes to the signs:
All Asset a/c balances = All liability (debt) balances
+ the Liability (DW) a/c balance
It is interesting to return to the beginning to see how the amounts in
the accounts build up so we can see the double entry process in action.
Let’s imagine a situation where an individual starts up with £20,000 in
a bank. For that individual to establish a double entry accounting
system, we need an asset account for the bank account and since there
are no debts, just a domestic wealth account; a double entry is required
for the initial transaction, with £20,000 debited to the asset account
for the bank and the same amount credited to the liability account for
domestic wealth. In business, this latter account is usually
called a Capital account. In the accounting equation, we can see
the result as:
Asset a/c bals £20,000 = All liability (debt) bals 0
+ Liability (DW) a/c bal £20,000
Now if we run a Trial Balance listing the balances of all the accounts
in our ‘books’, we will see an asset of £20,000 correctly balanced by a
liability of £20,000; also you will note that the single transaction of
starting up with £20,000 involved one debit posting and one credit
posting – which is an example of the implementation of the important
double entry bookkeeping rule for accounting.
Without going into the full details of mediation with my working
accounts, let’s see how we handle buying a car with a loan of £2,000.
By breaking it down into steps, we first consider receiving a loan – so
receive (debit) bank with £2,000 and setup a new liability type
account for the loan company and credit it with the same £2,000 - with
this effect in the equation:
Asset a/c bals £22,000 = All liability (debt) bals
£2,000 + Liability (DW) a/c bal £20,000
Still balanced at £22,000 on each side!
Now we buy the car for £7,000 using the £2,000 from the loan and the
extra £5,000 from the bank assets. We also need to setup a car
account to receive the value of the purchased car. The end result
from the equation perspective is still a balanced equation:
Asset a/c bals £22,000 = All liability (debt) bals
£2,000 + Liability (DW) a/c bal £20,000
The asset a/cs are now made up of Bank (£22,000 - £7,000) and car a/c
£7,000 with no change in overall value on the asset side but a
distribution in values across the asset accounts.
Another thought about double entry is that any single entry made to a
balanced equation (set of balanced accounts) must unbalance it!
The only way to retain balance is, from the maths perspective, add
something to an account on one side and add the same amount to an
account on the other side; or add something to an account on one side
and reduce by the same amount, in an account somewhere else on the same
side. This in effect, if you work it out, is what the accounting
rule says in that a debit posting must be balanced with a credit
posting.
So far we haven’t considered changes to domestic wealth. As we buy
food, drink and clothing, pay utility bills and purchase holidays, we
will see reductions or credit in our asset account for bank or, if we
pay by credit card, equivalent credit entries to increase our debts in
the liability type account for each credit card. These are
termed expenses and will lead to an equivalent decrease in our domestic
wealth. We don’t tend to constantly decrease our domestic wealth
account each time we have an expense but rather, accumulate all our
decreases in a ‘bucket’ account setup for domestic decreases; and
similarly for increases. It should be obvious that if we post
credits as the first part of each expense transaction, we will need
corresponding debit entries to balance them. Increasing debits
imply an asset type account so that will be the sort of account
that we need for these increases. By the same logic, income such
as salary or pension will be first entered as increases or debit entries
in our bank account and must be balanced by credit entries in a new
account for domestic increases – increases that are credit entries occur
in liability type accounts so this is the sort of new account we
need to setup for accumulating changes for increases to domestic wealth.
This is what the double entries looks like for expenses – a decrease
from a supermarket outing for £100 and £2,500 received for salary - the
result is a balanced £22,500 on both sides of the accounts and the
equations:
All Asset a/c bals + Decreases a/c balance = All
Debt a/c bals + Increases a/c bal + DW a/c bal
(£22,000 - £100 + £2,500)
£100
£2,000
£2.500
£20,000
(£24,400)
When the increases and decrease are applied to the DW a/c, we have
£24,400 on each side:
£24,500
= £2,000
+
£22,500
£24,500
=
+
£24,500
Non Double Entry Accounting
Traditionally, accounting for personal and home use has not made use of
the principles of double entry; and the software packages that support
home accounting are not usually geared up to properly support it.
The reason is partly because when people ventured into home accounting,
they tended to start with activities such as reconciliation of checking
accounts and simple budgeting. For this, they tended to only
require setting up accounts for one or two areas, mainly related to bank
accounts. With this, as useful as it is, there is no concept of
seeing the total picture, with the static and dynamic views of the
financial state of affairs.
Business versus Domestic Accounting
In fact we are a bit ahead of ourselves here since we haven’t yet seen why we might
want to use double entry accounting for domestic finances in the first
place!
When I first decided to start ‘doing’ my own home accounts many years
ago, I believed that since business accounting had evolved over such a
long time to be able to so successfully satisfy business managers’ needs
to manage business finances (and there was a legal requirement for them
to do so) there must be something special in business accounting
that I could look for, to be able to help people better manage their
personal and home finances. As described elsewhere, I discovered
that business accounting methods themselves were of little help because
of the wrong focus (profits for capital gain) and that the actual
accounts, reports and associated business ratios were also,
understandably, entirely inappropriate.
In thinking about alternatives, I realised there were some features that
could be extracted from business and with modification, be used
effectively to help manage home finances.
To explain which of the best parts might be useful, it is appropriate to
first take a quick look at the business approach to accounting.
Reports
With the double entry system we can obtain a static view or ‘snapshot’
of the state of the finances of a business and this is called a Balance
Sheet. This shows the assets, liabilities and capital value on any
particular day, so let’s look at an example:
This report gives us a good overview of the situation on a particular
day. Of course, the individual items are understandably, not at
all relevant to a household. The important issues are the makeup
of the assets, liabilities and capital. The one figure that needs
more explanation is that figure of £5,491 for Net Profit; and you
probably know that in business, this dynamic, as opposed to static
information, comes from the Trading account as modified by the contents
of the Profit & Loss account. It indicates change over some
period.
Before we look at these last two business accounts for the changes,
let’s compare the business balance sheet with my domestic balance sheet,
to see the differences.
Most of the entries in the business Balance Sheet come from balances in
the accounts which can be easily extracted from a Trial Balance.
The difference will be that for home accounting, we will have no need for the majority of
these particular business accounts in which the business figures are
accumulating. Here is an example of a Trial Balance which
shows the balances of all the accounts in the books.
I believe that many homesteaders would appreciate a version of the
Balance sheet for home and domestic accounting as I did and so this is
the first business feature that I adopted.
In the version above, in contrast to the business report, you see the
previous year’s figures together with those for the current year.
The statement essentially summarises the static situation of some home
finances on a certain day. It tells us everything there is to
know.
We understand from the accounting equation that the total assets less
the liabilities at any time, gives us the domestic wealth so looking at
the bottom of the statement first, we can see that the previous year’s
domestic worth plus the new domestic change is the same as the new
figures for total assets less total liabilities, the new domestic worth.
In passing, I call a domestic surplus a domplus, when the Total Domestic
Change (TDC) is positive, which you can contrast with a business profit.
This can be compared with a domestic deficit, a domicit, which is the
nearest equivalent to a business loss.
The structure and contents of the Domestic Balance Sheet (DBS) are
fairly self-explanatory and highlight the major components of the
domestic assets and liabilities. It would be a question of
personal choice how much information is included here but for a
household, it is so easy and informative to include all the major
components as shown here. A simpler or summary version would just
leave out some of the lower levels of detail.
Now, the big issue is what does the TDC, as a domplus of £25,900 consist
of? We know that the business equivalent of profit or loss is
exposed in those two accounts we talked about above. It would help
to have a quick look at an example of these business accounts first, so
let’s have a look at the business Trading account and the Profit & Loss
account.
This is the first of some dynamic views of business finances which
present information about changes happening over some period.
For business, the focus is on profits and so this account concentrates
on the higher level aspects of the business with opening stock, the
purchases made to augment this stock and the closing stock value.
Against this, we have the sales figures, together with the effects of
the costs of bringing in the stock; and changes due to stock and/or
sales items having to be returned. The difference is the gross
profit which is carried down to the P&L account.
The next account called the Profit & Loss account shows the impact of
other increases and decreases which usually reduce the gross profit to
some lower value, called the net profit.
At the bottom of this account, we can see that figure of £5,491 as net
profit that we saw earlier, brought into the business Balance sheet.
For business, these accounts adapted according to the nature of any
particular business, serve their purpose as intended. They are not
much use for a household though as fairly obviously, their focus is
completely inappropriate. The individual accounts required by
business have no place in home finances and I repeat, that we are not
primarily interested in profit.
The new Focus – Domestic Well-Being
What should the financial focus be for a home finances? Well I
gave much thought to this and over some years, developed a new focus
with an associated approach and methods, based on what I eventually
termed, Domestic Well-Being.
In short, yes, homesteaders do want to increase their worth or value,
but not usually for ‘profits sake’. People want to increase their
wealth to pay for things that tend to occur in a progression throughout
a lifetime; like better homes, education perhaps, hobbies, luxuries and
provision for those retirement and eventually, declining years when
income is drastically reduced. Finally maybe, if anything is left
over, people sometimes wish if they are not 'skiers' (spending
the kid's inheritance), to provide help in
the form of inheritance to the successors of the family for their future
lives.
In general, home finances in the earlier years of a lifetime are such
that there is never enough to go round. Everything is a question
of priorities and balance. What should be the best distribution of
our expenditure to ensure that we can obtain the best possible balance
or compromise, with the income at our disposal?
My solution was to come up with a structure that best presented the
major areas of domestic finances about which decisions could be made on
how best to allocate funds – those alternatives and their
prioritisation. So I needed a way that could be used to classify
increases and decreases as and when they occurred, as well as for
presenting the figures in an appropriate way after they had been
accumulated. This presentation had to support the decision
making that would be needed to best optimise future spending. It
had to be done in a way that could achieve this best balance across the
competing priorities so as to maximise Domestic Well-Being. It was
therefore DWB that became the new focus for domestic accounting; and it
could be identified in terms of a structure for both bookkeeping -
capturing the transactions; and accounting - reporting, analysing and
the subsequent decision making for future financial activity,
implemented perhaps through budgeting.
The Domestic Well-Being Statement
So let’s shortly look at a Domestic Well-Being Statement (DWBS).
This is the domestic version of the Trading account and the Profit & Loss
account and is used to present the derivation of the Total Domestic
Change (TDC) over some period. It is essentially an edited report
of the contents of the new, Domestic Changes account. For
completeness, it is best shown in full detail but could just as easily
be provided in a summarised form with some of the lower level detail
rolled up into the higher level sub-totals. It represents the
second of my adopted features from business accounting.
Although it perhaps looks complicated at first sight, this report simply
shows the structure for DWB and in un-edited form, is obtained in
Microsoft Money with one click to run a pre-stored report. This
edited version combines the details for the current and previous years
to assist with comparisons.
In summary, the report shows the three top-level Categories of the
structure as the Basics, Discretionary and Others
groups of transactions, each divided into Increases and Decreases.
These categories might be considered as similar to business accounting
nominal codes.
Within these groups there are successively lower level groups of sub and
sub-sub categories. For example, the Basics included
Essentials, Responsibilities and Family, each with further
sub-categories below.
The Discretionary group, where obviously there is some amount of
discretion or choice as to whether decreases and increases occur in its
component sub-categories, includes Nice-to-Have, Investment for the
Future (IFF) and Luxuries.
We will look at ways in which information from this statement can be
used in the analysis process, to help decision making in support of any
changes that might be contemplated for the follow-on period.
What amazed me when it was first developed was the fantastic visibility
it provided on the home finances, especially showing the distribution
and makeup of the many expense items.
Please take some time to study the DWBS in order to be able to
appreciate what a range of information it contains. Also, remember
that it is only a summary and that all the underlying information in
terms of which transactions were included in each sub-category is just a
mouse-click away; as is the detail about the accounts from which the
transactions originated.
Another statement common in business accounting is the Cash Flow
Statement. A domestic version of this report can also be easily
created but is not shown here as it could be considered as perhaps a
report of a more optional nature, in home accounting.
Financial Ratios
The third feature that I adopted from business accounting is the use
made of financial ratios.
You will appreciate that a ratio is simply a comparison of two figures
expressed as a quotient, usually in decimal or percentage format.
In business over time, certain key quantities and their comparison in
the form of ratios have taken prominence as a key to both information
dissemination (for shareholders, investors, management boards, auditors
etc.) and to various levels of management as a basis for control.
Those two components of a ratio, the numerator and denominator, can both
be considered as candidates for achieving change. Changing
something to affect the value in one of these ratios may have untoward
affects as through feedback, other ratios may be affected that focus on
some other aspect of the overall business figures. Business of
course spends much time on ‘what-if’ spreadsheets, simulation and
modelling as part of ratio analysis, to try to determine the optimal way
to effect the changes to achieve the business aims, whatever they might
be.
Business figures, like the domestic figures above have countless
possibilities for utilising and comparing two numbers from the reports
to establish useful ratios. There is also the need to compare like
with like – two changes or flows over a period or the proportion of two
static values such as fixed assets against total assets, on a particular
day. Over 30 business ratios slim down to few that most people
have heard of, such as the different forms of margins and the ratios
associated with profitability and liquidity; and of course virtually
none of them relate to domestic finances!
From my experience a long time ago with modelling, simulation and
control of road traffic, I knew that the figures I had exposed for
domestic finances must have some potential for assisting in the
management and control of home finances. The issue was which
figures and in particular, which groupings of pairs of figures as ratios
might be informative.
The Stages of Domestic, Financial Life
My other
experience was with life; now 68, I realised looking back on my lifetime
of interest in home finances, I could distinguish six fairly distinct
stages of financial life. By this, I mean that there was a
significant enough change in some aspect of personal finances across the
stages that might warrant some form of indicator or measurement being
useful. For your interest, I call these stages:
Early Adulthood
Early Maturity
Middle Life
Retirement
Declining Years
It is not appropriate to prolong this discussion of ratios in this
introduction; but to summarise, I have defined five primary factors and
a number of secondary factors for domestic finances, changes in which I
believe have a correlation with those stages of financial life and could
be useful as a basis for comparison and more detailed analysis.
Briefly, the more important ratios over some period are (where the
abbreviations relate to figures in the DWBS):
Basic Cost of Living Factor (BDD/THI) – a measure of the amount
spent on basic necessities, out of total household increase.
Well-Being Contribution Factor (DDD/THI) – a measure of the
amount spent on discretionary extras, out of total household increase.
Future Affordability Factor (IFF/TDI) – a measure of financial
commitment to future well-being, out of total domestic increase.
Feel Good Factor (IFF/DDD) – a measure of how much went on future
well-being, out of total discretionary decrease.
Domestic Wealth Factor (TDC/ODW) – for positive TDC the domplus,
or for negative TDC the domicit, contributing to growing or diminishing
domestic wealth respectively, as a proportion of old domestic wealth.
This is the nearest comparison to business profit or loss.
To start with, lacking any reservoir of accumulated figures, the value
of these ratios or factors as I call them for home use, will only be of
use internally in a household over time, as a means of measuring and
looking for changes. With a base of figures, then there would be
the possibility of comparison with others and the similarity to
business norms that are used to compare like with like as a measure
of conformance or acceptability with other similar entities.
Value for these five factors give ‘shape’ to a financial situation and
if displayed in the format of a star or radar diagram, I believe could
also offer useful indicators that could help to predict problem areas or
states of stability or instability about a set of finances; more
research would be required in this area, as well as for using simulation
to accumulate a base of domestic factors as domestic norms, as
basis for comparison.
With an accumulation of values for the domestic factors, either by
simulation or by capture after creation by individual home owners, it
would become feasible to create and provide charts such as the
‘artificial’ one shown below. This would enable a home owner to go
in with salary on one axis and to be able to determine for family size,
the expected value of a factor such as the Basic Cost of Living Factor
(BCLF). It would be likely that different values for each factor
would be appropriate corresponding to the different stages of domestic,
financial life. With such information, the home owner would be
able to determine if the individual figures from the accounts appeared
to lie within the expected domestic norms.
Other Graphics
A picture speaks a thousand words. This is no truer than when considering
displays of financial information. Here are a few examples as the
fourth set of business features of the sort of products that can easily
be created with general purpose accounting software packages such as MS
Money, especially if double entry accounting is used. Some of
these required a data transfer (1 click) from MS Money to a spreadsheet
package for further exploitation.
Annual Utilities Expenses (Sorted by amounts)
Financial Control
The subject of control is stimulating and quite complex; it relates to
targets, what is controllable and what should be controlled; and to
measurement and comparison. For home finances, I am sure that
control is both feasible and realisable and is only limited by the
extent to which homesteaders wish to go. It all comes back to that
issue I have raised elsewhere, relating to a need for a sense of
responsibility.
The analysis, once figures have been produced at the end of some period,
should first look at distribution and balance. Are the proportions
for example, being spent on the Basics, a fair amount compared to the
total increase?
The information obtained from your end-year results should reveal or
tell you, some fundamental facts. Have you been able to afford
anything, over and above the basics? If the answer to that is
positive, did the amounts enable a reasonable allocation to
discretionary decreases, and what about luxuries?
At the next category level down, what does the distribution look like,
within the basics, and within the discretionary categories?
For the basics, do you have a reasonable distribution between
essentials, responsibilities and local-to-family concerns?
Your accounts and this new set of accounting methods will give you the
data and information to enable you to pick up warnings.
What sort of warnings might you want? In today's climate of a
financial debt crisis, probably the most important warning you would
look for, is one relating to the likelihood of such a pending crisis for
you. You would want to know if your decreases are getting too
close to your increases, or even exceeding them. You would want to
know if your reserves are being depleted, possibly on funding that
excess of decreases over increases. You should be looking to see
the amount of short-term and long-term liabilities you have, to see how
they compare to the previous year's figures; and how their proportions
compare to the total value of assets (one of the new, secondary
financial factors). You would want to know about your liquidity;
how well you are able to realise funds in the short term to meet your
known commitments. You obviously do not want to sell your house or
car just to pay the bills.
On a less dramatic but more important note, you need to know about the
proportion of contributions being made to future well-being; and if
positive, does the amount being put aside represent a reasonable
proportion of your increases?
Your 'responsibilities' subcategory, under the basic decreases
category is important and so you should guard against any indications of
potential difficulties in this area.
In relation to well-being, we looked at some of the perhaps, less
significant aspects of contributions to improving domestic well-being,
so warnings in this area would be pertinent.
Rather than alarm-bells, a conscious decision once in a while to look at
decreases occurring in the sub-categories of 'Nice-to-Have' would do no
harm. Check to see if you are making reasonable, affordable and
balanced expenditure in these areas, such as on holidays, entertainment,
leisure and hobbies.
Apart from warnings, any changes that break the past patterns of
domestic increases and decreases must be detected and verified.
Detection involves a quick, manual scan down the results of the formal
reports - the DWBS, and DBS - for anything unusual, particularly
compared to the previous years. Anything detected that is unusual
requires further analysis, with perhaps, comparisons with figures
further back in time or detailed checking in the accounts themselves.
With experience, you will realise that account details can be examined
from so many different places such as the categories, payees and budget
screens, as well as from the results of the various reports obtained
directly from the accounts.
Conclusion from Adapting Business Accounting Concepts
In order to
implement the features I have extracted from business accounting, I
needed to be able to use the concepts of double entry that I described
earlier. The implication was simply that I would need the few
extra accounts to make the concept of balanced accounts possible for all
the financial aspects of a household, together with some double entry
bookkeeping techniques to subsequently keep the domestic accounts
properly balanced.
Simplification
In my own
experience, I did find business accounting ideas very difficult in the
early days. Although I completed a business studies correspondence
course some 40 years ago in conjunction with a career change (but didn’t
actually need it in the end!) I found I knew enough to get me started
when I began to investigate implementing my own home accounts when
computers like the Commodore 64 emerged on the scene.
In undertaking home accounting in conjunction with double entry, the
main difficulties I realised, related to knowing where I was in relation
to individual accounts and the entering of transactions. By this,
I mean that when looking at a single account register on the computer
screen, it never appeared obvious to me what sort of account I was
looking at and into which column of the account, the next posting should
be made.
Over time, I realised that the key to understanding the answers to this
dilemma lay with the accounting equation. The mathematics of
keeping accounts balanced was quite easy and from school maths, it was
just a matter of applying those rules I discussed and demonstrated
earlier. This was all about posting the value of a transaction
equally to two accounts on the opposite sides of the accounting equation
(with two increases or two decreases) or applying opposite postings to
two accounts on the same side of the equation (with one increase and one
decrease).
To make this implementable, I needed a way to always be able to
associate any account with its place in the accounting equation – asset
or liability. Since we have those two basic types of
account which dictated which side of the equation they belonged to and
in my system, I had defined a number of subcategories for each of these
asset and liability accounts, so all I needed was a two-character prefix
in front of each account name. With this, I always knew by looking
at an account name, exactly what its purpose was and where it resided in
the domestic accounting equation.
The first character of the prefix was always A or L – for Asset or
Liability. For asset accounts, I have sub-categories for Fixed
Assets (AF), Investment Assets (AI), Working Assets (AW) - which are
those accounts for mediating certain of the transaction postings; and a
final pair of sub-category which I call Quasi Assets (AQ); and Quasi
Liabilities (LQ) in the liabilities group. Sub-categorising certain
accounts as ‘quasi’ accounts was my way to distinguish between true
assets or true debts and the assets and debts associated with domestic
wealth or business capital.
Like many amateur accountants I always had problems with reconciling the
concept of debts in accounts for mortgages and loans, with a so-called
liability related to an amount in a capital or domestic wealth account.
To me, domestic wealth was a ‘good’ liability – more was better – whilst
the mortgage and loans were ‘bad’ liabilities or debts that had to be
repaid; and more was not better, but worse! I resolved this by
considering all the accounts that were associated with domestic
liability as quasi-liabilities – good liabilities; the amounts or the
balances of liability held in these accounts, I considered as ‘good’
liabilities, not debts that I should be worried about but that could be
left to my executors to sort out in the future.
There are a total of four accounts that fell into this quasi group which
consisted of the Domestic Wealth account (LQDW), the Domestic Changes
account (LQDC), the Categorised Increases account (LQ Cat Inc) and the
Categorised Decreases account (AQ Cat Dec). The Domestic Changes
account is the home accounts equivalent of the business Profit & Loss
account. As such, positive contributions from gains on disposals,
appreciation of the value of the family home and of investments, all end
up here. The balance of this account will similarly be reduced by
for example, decreases on disposals and any depreciation on the car or
our investments. So at the end-of-period, the final balance in the
Domestic Changes account, as Total Domestic Change (TDC), will be passed
to the LQDW account. It is the TDC that is the final balance of
the DWBS and which also appears as the last entry on the DBS.
The majority of the changes to domestic wealth over any period come from
the decreases associated with expenses such as food, drink, clothes,
utilities, holidays etc – virtually all of the Basics and Discretionary
decreases. These also end up in the LQDW account via the LQDC
account but because of the way I handle most of the double entry
postings, they arrive via those two quasi accounts for Categorised
Increases and Decreases that I discuss below, under Implementation.
In the Domestic Changes (LQDC) account below from MS Money, you can see
the categorised increases and decreases being brought into the account.
Finally at the end-of-period, that amount of £25,900 as the TDC is
passed to the Domestic Wealth (LQDW) account so that the DC account is
zero, ready to accumulate changes during the next period.
Implementation
Once the PC compatibles arrived, I migrated from the Commodore and chose
one of the earliest versions of a generalised accounting software
packages called MS Money. Being generalised, it provided the
capability to create accounts as needed, with any name you chose.
It also had very good integrated query and reporting capabilities,
together with the concepts of payees, categorisation tags and support
for budgets as well as for stocks and shares.
The product later became very bloated with all sorts of associations to
web sites for purchasing financial products. However the basic
accounting components remained fairly static with an important later
introduction of support for the on-line uploading of transactions from
financial institutions, such as banks and credit card companies. I
always use a semi-automated approach to bookkeeping so that I can remain
totally in control of what goes into my accounts and also be aware of
all the changes. With fully automated updating, you could easily
fail to notice some important transactions – although they would always
be present in the accounts and accessible at any time through direct
observation and via reporting.
In thinking about the implementation of double entry, MS Money was not
designed primarily for double entry. If it was, it would have some
journal-like arrangement similar to dedicated double entry accounting
software, whereby each transaction is associated in some way with the
two accounts involved in the double entry. Then, via a key-click
or later batch updating, the two individual postings would be made to
the appropriate two accounts.
This does not mean to say however that this package cannot be used for
double entry postings. All it requires is that after adding the
necessary extra accounts, that two entries are posted for each
transaction entered. I have mentioned that categorisation tags are
provided with MS Money and there are two sorts – Classes and
Income/Expense tags. The idea here is that with the power of
software, tags can easily be provided and their use made available
behind the scenes for linking tags to the individual transactions.
For example with classes, if there were two properties or two
individuals associated with a set of accounts, each transaction could be
referenced as appropriate, to a class entry so that later, via
reporting, all the financial aspects of one property or person in
association with perhaps dates or particular accounts, could be easily
extracted.
The other form of categorisation available in MS Money is its Income and
Expense tags. Money comes pre-loaded with tags associated with
home finances so that for example, with a simple account (non-double
entry system) account for reconciliation with bank statements, each
transaction could be associated with an appropriate tag, such as wages,
food, etc. As well as a pure tag with a link to some category,
their association can be to income or expense. These are the terms
used in MS Money to relate to the accounting terms of debit and credit;
and unfortunately they are not associated with the traditional left and
right orientation in each account register of debit on the left and
credit on the right. Perhaps trying to be helpful to home
accountants, MS Money has differing column headings for the increases
and decreases across all the various types of accounts that can be
created. I found this very confusing; and I would prefer just
debit and credit or just income and expense. I resolve this
problem with some simple ‘memory joggers’ that makes it nearly
impossible to go wrong!
In the days of manual computing, there was no automation to support the
implementation of tagging so the effect had to be achieved by manual
methods. This meant for example, creating individual accounts for
each class of information and accomplishing the necessary bookkeeping
such that it would have been a very laborious and time-consuming
process.
In trying to find a way to implement the tagging I needed to associate
transactions with the DWB structure as well as achieve double entry to
support the concepts of static and dynamic reporting, I came up with a
method that achieved both, without the need to enter transactions with
hundreds of double postings. This combined tagging to do two jobs
– provides the journalising cross-referencing needed to associate each
posting with its ‘partner’, as well as to ‘mark’ each 1st
half of a double entry at its time of original-entry.
The 1st halves of the appropriately, categorised double entries
accumulate in the accounts where they were entered, mostly bank or
credit accounts but that is unimportant. At the end-of-period by
running a single report, the sum of the amounts of the 1st
half entries can be easily exposed, contributing separately to increases
and decreases to domestic change. By then entering just two more
postings, one for the total of the 1st half increases and
another for the total of the 1st half decreases, balance is
re-established.
These two final postings could be made directly into the Domestic
Changes account but it is more useful to distinguish the categorised
contributions to TDC, from uncategorised ones. This therefore is
the explanation for those two quasi accounts, the AQ Categorised
Decreases account and the corresponding, LQ Categorised Increases
account. Their balances of course are eventually transferred
through the LQDC account to the LQDW account, as part of the
end-of-period processes.
Summary of the Approach
The main features that I have adopted from business accounting are the
ability to create balance sheets, to capture the financial changes over
a period, to define ratios/factors as a comparison of useful and
significant figures from the balance sheet and changes, as well as the
use of graphical reports to enhance visibility and meaning.
In contrast, what I have left behind from business accounting is most of
the individual accounts by name which, of course quite understandably,
have no bearing on the character of home finances.
I have also given much attention to simplification in order to make
accounting as easy as possible to undertake at home. In the Trial
Balance which lists all the account balances at some particular time,
for the current and previous years, you can see how the prefixes help to
show the purpose of each type of account and by implication, where it
lies in the equation.
In this version, I was calling the Categorised Decreases account a
so-called working account (AW) but now, I more correctly classify this
account as the one and only AQ account.
As a thought about setting up DWB accounting for yourself, my book
describes the background and theory, together with the details and
prototypes for accounts, categories, reports and graphics on a bonus CD
for implementing the system on MS Money.
I believe that the methods should also be capable of being implemented
on any general-purpose accounting software with good reporting
capabilities and support for categorisation. See also
Implementation Issues.
Regarding implementation on dedicated double entry accounting software
packages, I have not yet discovered any that are sufficiently
general-purpose to enable the creation of accounts of your own choosing,
together with your own details of categorisation. I suppose again
understandably, these packages have been developed specifically to
support business accounting. The accounts and their structure
therefore, together with the associated processes are so intimately tied
to business accounting concepts to make their adaptation to support home
and domestic accounting impossible.
As a final thought on simplification, life in the accounting world can
be made much easier for domestic accountants, if the terminology is
simplified as much as possible. It will be important not to remove
too much of the distinction between some of the technical words but I
have found that I have made life much easier for myself, by simplifying,
wherever possible.
In addition to simplifying, you will already realise that I have added
some words and techniques that also, I believe, add to understanding.
To summarise, for domestic accounting, I try to avoid the use of
the following words:
Capital, revenue, receipt, payment, profit, gross, net, real, nominal,
journal, ledger, margin, sales, purchases, commission, debtor and
creditor.
In contrast, the following words from business accounting are relevant
and meaningful:
Asset, liability, debit, credit, income, expense, gain, loss, payee,
fixed, current, long-term, investment, transaction, entry and
post/posting.
The final group includes the new words:
Temporary or Working accounts, increase, decrease, Domestic Change
account (DC), Total Domestic Change (TDC), domplus, domicit, Domestic
Wealth (DW), quasi-asset (AQ), quasi-liability (LQ), categorisation,
cross-referencing, tags, tagging, indexing and account name prefixes
(AF, AI, AC, AW, LL, LC, LW, LQDC and LQDW). This group also
includes all the new components of the domestic well-being (DWB)
structure and all of the new Domestic Financial Factors (DFF) as well as
the reports DWBS, DBS and DCFS.
An understanding of one idea - double
entry - and the following, six key words, will get you through with
flying colours: asset, liability, debit, income, credit and expense; and
my version of the domestic accounting equation and a couple of 'memory
joggers', will tie all these features together - so, no problems! Have
fun, and enjoy the benefits that can so easily, be yours.
'Accounting for a Better Life', an authoritative book, written with
rigour and thoroughness, is published by Troubador Publishing Ltd. under
the Matador imprint (www.troubador.co.uk)
and became available from August, 2007.
copyright © 2006 John M Passmore
Have a look at the
General Introduction
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