Recording Income and Expenses

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:

Table 1. Accounting for Salary

AccountDebitCredit
Chequing Account1,600.00 
Salary 1,600.00

This may be readily extended to a greater number of "split" items thus:

Table 2. A More Complex Paycheque

AccountDebitCredit
Chequing Account1,300.00 
Income Taxes200.00 
Health Plan100.00 
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.)

The words "Income" and "Expense" are beguilingly simple; everyone thinks they know what they mean. The money I get is income, the money I spend is expense, right? Yes, but only in a very basic sense. This may be enough when doing personal accounting, but for a business, things get more complicated. Income and expenses may be recognized as having occurred at a moment that is different from the moment when cash actually moved into or out of the business's bank accounts.

For instance, companies usually recognize income when the sale occurs. For example, that might mean that you recognize a $10,000 sale at the moment you and the customer shake hands on the deal. Since the money hasn't actually come in, the sale has to be posted in another way. You must accrue a sale at the time of the handshake. To make the transaction balance, you add the $10,000 sale to Accounts Receivable, rather than adding something in to cash.

Insider Knowledge: When a sale is recognized and how its recorded is governed not only by accepted accounting principles, but also by local and national laws. In the United States, accepted accounting practices are determined by FASB, the Federal Accounting Standards Board.

(The documentiation should state that for more info, click to the a/r/ and a/p page).