Learning about accounting is best done by looking at various actual applications. Based on last week’s post, we’ll look here at a case that is not about managing your personal finances, but about managing finances for different parties with a lot of interconnections.
The example here is from an actual use case (names and numbers adjusted), and not made up. It might be a bit more complicated than what you usually would come across, but not exceptionally so.
I can only highly recommend that you open a clean GNU Cash file and play with the stuff I talk about here. It’s much easier to understand if you actually use it.
So, what are we trying to manage. The situation is that a family member died. The estate and everything needs to be liquidated and the resulting money split up between two beneficiaries. So far, so easy. To complicate things slightly, the late family member also was managing a rented-out flat for some other family members. The flat is not part of the inherited estate, but it still needs to be managed.
A quick survey revealed that there is only a checking and savings account, some cash (including some cash hidden at home, of course), and a flat full of stuff that might or might not be worth something. Additionally, there are some contributions still due from managing the flat (running costs still to be paid by the renters).
The flat being rented out needs to be managed still, and of course we need to manage our own expenses for the managing of all of this to be deduced from the total payout.
There were two insights (and a good friend with good advice) that helped me to come up with a setup to manage this. The first was that there are two “you” involved in this. There’s “you, the manager” and there’s “you, the beneficiary.” The second thing to realize was that, contrary to the personal accounting setups discussed before, there are no income or expenses. What is happening here is that we are managing money for others. If we spend money on anything, someone’s invested money is reduced. If we get money, e.g. from the bank, someone’s invested money is increased. We manage money belonging to different pots, but we do not have income, expenses or profits as such.
If that confused the hell out of you, don’t worry, it’ll (hopefully) become more clear as we move on. Let’s set up accounts.
- Management (Assets)
- This is the actual money that you have in various accounts or as cash. It’s the money you are managing for others.
- Liabilities (Liabilities)
- The direct liabilities. E.g. when you (person) pay for a train trip, this is where that money comes from.
- Inheritance (Liabilities)
- The actual inheritance account. This account and its subaccounts manage the money the beneficiaries should receive eventually.
- Rent (Liabilities)
- The rent for the flat needs to managed, too. This is where it accumulates and where some payments come from when they are done from that money.
- Running Costs 2011 (Liabilities)
- Running Costs 2012 (Liabilities)
- When renting out a flat, you have some running costs that should be paid by the renter. They pay a monthly fee, but as it’s impossible to foresee the exact needs, the monthly fee might not cover everything (or even cover too much). This account takes care of managing this for a single year. I do a new account per year because payments can overlap, and I need to make a bill per year.
Each of these liability accounts manages a different “pot” of money. They’re all set up so that they will have a total balance of 0.00 when their respective task is done. Let’s take a closer look at each of them in turn and how that works out.
Management Account (Assets)
This is the most boring one, and should be quite familiar to you: Different bank accounts (including the ones of the late person), possibly some fixed assets, etc. The actual money and assets that you (the manager) now own to manage all the different funds.
Again, a pretty standard account. When you take a train trip and pay it with your personal money, you want that money back eventually. Let’s take a closer look at that.
You buy a train trip for 100 EUR to manage some inheritance questions. To book this, you transfer 100 EUR from the Inheritance:Estate:Expenses to the Liabilities:Me account. Which means that the I:E:E account is now smaller: There is less money to distribute from the inheritance (it got spent on the train trip). The L:M account is now larger: The management owes money to me-the-person.
That sounds accurate. (Homework: Do the above with correct signs.)
We already talked about that just now, but let’s take a closer look. This is the main account that tells us how much money there still is left from the inheritance.
Say the savings account has 10,000 EUR in it. You book this from this account to the Management:Savings Account. This results in the Assets account to go up. That’s correct: There’s money on it. It also means that this account goes down. That’s also correct: You-the-manager owe the beneficiaries of the inheritance this money. You only have it on the bank account to manage it, you still need to pay it back. So, this seems to work.
But there’s a slight complication: It’s quite possible that one of the beneficiaries wants some of their money before the whole thing is closed and done with. You somehow have to keep track of how much you already paid out. For this, we first make two subaccounts of the Inheritance account.
- Paid (Liabilities)
- This is the account hiearchy where you track what has been paid out. Create one subaccount per beneficiary. If you pay them money, transfer money from the assets account here.
- Estate (Liabilities)
- This is the actual account to track the total estate. You likely want some subaccounts to track the original estate before any payments, and some other subaccounts to track what kind of expenses you-the-manager had, but it could all go into the same account all the same.
Say at the end of it all, you want to split the inheritance in half for each of the two beneficiaries. You take the total value of the Inheritance:Estate account. That’s what each of the beneficiaries should get. You can check in the Inheritance:Paid accounts what they received already. Deduce that from the payment, and transfer the money from the bank account to the I:P subaccount.
If all is well, at the end, you will have two equal values in the I:P subaccounts, and the Inheritance account has a balance of 0, because the Inheritance:Paid account has the same value (just negative) as the Inheritance:Estate account. Once you are there, you’re done!
This is the account to track the actual rent paid by the renter, excluding running costs. The setup incidentally is the same as the Inheritance account: A Paid subaccount and a Received subaccount. The Paid account tracks how much each of the shareholders of the flat already received. The Received account tracks how much you got. Usually, you want to keep some percentage back to pay for special expenses, but the rest will be paid out to the shareholders.
This works just the same as the Inheritance account.
And once you sell the flat, you just have to make sure that this account has a balance of 0, just like with the Inheritance account, and you know you are done.
Running Costs YYYY (Liabilities)
These are similar, but slightly different to the two accounts mentioned above. Again, you receive money (from the renter) and you pay money (the various running costs). At the end of the accounting period, you can easily check the Paid account to see how much you actually paid in the period. This helps adjusting the regular rate the renter pays for this. The total value of the account then tells you how much the renter still owes you—or how much you still owe them.
Example: Rent Payment
After you set up the accounts and everything, the renter for the flat paid rent for December 2011. This still belongs to the inheritance, the new flat management only takes over in January 2012. The rent is 300 EUR, the running costs is 200 EUR. The renter sends a single transfer of 500 EUR. How do you book this?
This is a split transaction.
|Management:Checking Account||+500.00||Well, the checking account increased, obviously.|
|Inheritance:Estate||-300.00||We owe the rent to the beneficiaries.|
|Running Costs 2011:Received||-200.00||And the running cost pre-payment was received. This is negative because we basically owe it to the renter. We only actually take it when we compare it with the payments we made.|
Looks good. In the coming months, the rent will be paid very similarly. Though this time, the account for the rent will not be Inheritance:Estate, but Rent:Received. That will also be negative, because we owe it to the beneficiaries. All is well, and we have a very clear idea of what is going on.
That’s it. You now have the different “pots” of money nicely sorted out. Each of them tells you how much you-the-manager still owe those people. If you want to finish the management of one pot, you simply make sure that its balance is zero. Once that happens, it’s done and you’re off the hook.
The sum of all accounts, incidentally, is always 0.00. This is because the money you have in the Assets accounts is simply the money you have because you owe it to all the different parties. This whole system simply tracks changes in who you-the-manager owe the money to.
Simple, isn’t it!