Other articles on Domestic Well-Being Accounting (DWBA) have hinted about the new ideas upon which this new domestic accounting model is based. In this article, the rationale, ideas and concepts are summarised, based on the coverage in a new book ‘Accounting for a Better Life’.
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 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.
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 account and the other is a liability 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 this 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. 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 such as a car or 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 as 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.
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 lies at the heart of DWBA accounting is so-called, double entry. This concept appears confusing to people because it has two 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, an entity might be a department or a division, a sole-trader or even a whole plc. For domestic accounting, 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 at igitems.com. As such, the accounts will be able to capture and make visible both the static and dynamic aspects of the entity finances. 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 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 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.
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 is that we need to setup an additional account in order to store the amount of our changing domestic worth. I 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. It should therefore 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
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 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
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, if we add something to an account on one side then we must add the same amount to an account on the other side; or if we add something to an account on one side we must 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.
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. 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.