Chapter 1
Financial Statements: Personal Accounting
20
Capital
So far, we have discussed that the most common way to increase net
worth is to earn revenue in an amount that exceeds your expenses.There
are other ways to increase your net worth, such as winning the lottery or
receiving a gift. These are not considered revenue since they were not
earned, but they do increase your net worth.They are known as
capital
.
Part of the accounting function is to manage your finances by recording
your monthly expenses and matching them to your monthly revenue.
Capital items (such as gifts or lottery winnings) are not everyday revenues
and are therefore recorded directly to net worth instead of the revenue
account.
It is important to separate records of revenue received from regular activi-
ties (earning wages) from other infrequent increases to net worth (gifts)
instead of pooling them all together. Keeping them separate will allow
you to properly manage your finances month-to-month.
The accounting equation shows net worth at a particular point in time.However, net worth changes
over time as you earn revenue, incur expenses or receive capital.The following formula shows how
to calculate the ending or closing balance of net worth over a period of time.
Ending Net Worth = Beginning Net Worth + Capital + Surplus (Deficit)
You will recall that the beginning balance, or opening balance, is the balance at the beginning of the
period. Capital is any transaction that increases your net worth which is not considered revenue.
The surplus or deficit is from the income statement for the period. A surplus will increase net worth
and a deficit will decrease net worth. At the end of the period, the accounting equation must still
balance, so that assets must equal liabilities plus the ending net worth.
T-Account Transactions
To demonstrate how the T-accounts can be used to record the various financial transactions that
happen during a period, and how the income statement is linked to the balance sheet, we will
examine several transactions. A
transaction
is a trade or exchange with someone else in order to
receive something of value.
We will begin the month with opening balances for assets, liabilities and net worth.These opening
balances are the ending balances from the previous month. The opening balances of the asset
accounts will normally appear on the left side of the T-accounts (increase side), and the opening
balances of the liabilities and net worth will normally appear on the right side of the T-accounts
(increase side).
2
ASSETS
PERSONAL BALANCE SHEET
LIABILITIES
CASH
PREPAID
EXPENSES
HOUSE
AUTOMOBILE
CONTENTS
OF HOME
UNPAID
ACCOUNTS
MORTGAGE
LOANS
NETWORTH
+ $3,000
+ $3,000
______________
FIGURE 1.36
