9

After taking an introductory financial accounting class, I decided to use GnuCash to keep track of my personal finances. I have 5 major accounts in my general ledger:

  1. Equity
    • Currently only used to record opening balances for other accounts.
  2. Assets
    • Subaccounts for Bank, Cash, etc.
  3. Liabilities
    • Subaccounts for Credit Cards
  4. Income
    • Sources of income, such as Salary and Gifts.
  5. Expenses
    • Sources of expense, such as Groceries and Gas.

This worked out well for the past year. However, I've recently had to record the capital losses I made on a short-term forex trade, but I can't remember how to record this.

In particular, do I use two separate accounts as such:

  1. Income > Capital Gains
  2. Expenses > Capital Losses

Or just one Capital Gains (Losses) account where a negative balance indicates a capital loss?

if just a single account, would this account be under Equity or Assets?

3

First, the balance sheet is where assets, liabilities, & equity live.

Balance Sheet Identity: Assets = Liabilities (+ Equity)

The income statement is where income and expenses live.

General Income Statement Identity: Income = Revenue - Expenses

If you want to model yourself correctly (like a business), change your "income" account to "revenue".

Recognized & Realized

If you haven't yet closed the position, your gain/loss is "recognized". If you have closed the position, it's "realized".

Recognized Capital Gains(Losses)

Assuming no change in margin requirements:

  1. Increase/decrease the "recognized capital gains" account under assets by the increase/decrease in the value of the position
  2. Increase/decrease equity by the increase/decrease in the value of the position

Margin interest should increase margin liabilities thus decrease equity and can be booked as an expense on the income statement.

Margin requirements for shorts should not be booked under liabilities unless if you also book a contra-asset balancing out the equity. Ask a new question for details on this.

Realized Capital Gains(Losses)

  1. Credit off the position (the initial cost & any accumulated recognized capital gains/losses) under assets
  2. Debit off any liabilities (margin) due the position
  3. Debit cash in the amount of the liquidated position
  4. Increase/decrease equity by the gain/loss due to the position if they haven't been marked under "recognized capital gains/losses"
  5. Mark the sale of the position as "Revenue"
  6. Mark the buy of the position as "Expenses"

Balance Sheet Identity Concepts

One of the most fundamental things to remember when it comes to the balance sheet identity is that "equity" is derived.

If your assets increase/decrease while liabilities remain constant, your equity increases/decreases.


Double Entry Accounting

The most fundamental concept of double entry accounting is that debits always equal credits.

Here's the beauty: if things don't add up, make a new debit/credit account to account for the imbalance. This way, the imbalance is always accounted for and can help you chase it down later, the more specific the account label the better.

  • Let me see if I have this correct for simple capital gains: suppose I bought a widget for $10, and then immediately sold it for $20; so I would start off with $10 in a Asset > Widget account before the sale. – Vilhelm Gray May 22 '13 at 13:16
  • To account the sale I would: decrease Assets > Widget by $10, decrease Assets > Capital Gains by $10, and increase Assets > Cash by $20? This confuses me because Assets > Capital Gains is now negative. – Vilhelm Gray May 22 '13 at 13:16
  • Thanks for the clarification (I'm still wrapping my head around terminology). So if I have this correct, recognized capital gains are just periodic adjustments I make to account for the change in value of my widget over time, while realized capital gains are what I actually make when I finally sell? If I'm not keeping track of the unrealized capital gain (as the case in my earlier example) would I just jump directly to the Realized Capital Gains steps? – Vilhelm Gray May 22 '13 at 14:23
  • As a second question: what account funds the Access > Recognized Capital Gains account? I think the funds are coming from an Equity account, but I'm not sure if this would share the same name with Recognized Capital Gains. – Vilhelm Gray May 22 '13 at 14:26
  • I see the source of my confusion: I had the meaning of the words "debit" and "credit" backwards in relation to Assets and Equity respectively. I understand now, thanks. :) – Vilhelm Gray May 22 '13 at 15:08
4

Capital is an Asset. Decreasing value of capital is the decreasing value of an asset.

When you buy the forex asset * DR Forex Asset * CR Cash

When you sell * DR Cash * CR Forex Asset

The difference is now accounted for

Here is how:

Gains (and losses) are modifications to your financial position (Balance sheet). At the end of the period you take your financial performance (Profit and Loss) and put it into your balance sheet under equity. Meaning that afterwards your balance sheet is better or worse off (Because you made more money = more cash or lost it, whatever).

You are wanting to make an income account to reflect the forex revaluation so at the end of the period it is reflected in profit then pushed into your balance sheet.

Capital gains directly affect your balance sheet because they increase/decrease your cash and your asset in the journal entry itself (When you buy and sell it).

If making money this way is actually how you make you make an income it is possible to make an account for it. If you do this you periodically revalue the asset and write off the changes to the revaluation account.

You would do something like *DR Asset *CR Forex Revaluation account; depending on the method you take. Businesses mostly do this because if the capital gains are their line of business they will be taxed on it like it is income. For simplicity just account for it when you buy and sell the assets (Because you as an individual will only recognise a profit/loss when you enter and exit).

Its easier to think about income and expenses are extensions of equity. Income increases your equity, expenses decrease it. This is how they relate to the accounting formula (Assets = Liabilities + Owners Equity)

  • I'm a bit confused, how does this account for a capital gain (loss) if no Capital Gain (Loss) account is involved? – Vilhelm Gray May 21 '13 at 14:14

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.