This chapter is a bit technical it shows how traditional accounting has been done, to what basis it may lead and how the wealth formula improves it. The dear reader, who is not an accountant and does not care about the accounting mindset, its procedures and processes can easily skip this chapter without losing anything. A lot may get confused about the following so read it only fòr your information than delete it and stick to the wealth formula and you won’t have any problems evaluating your wealth.
So how is traditional accounting been done? It is all about balancing Debits (Dt.) and Credits (Ct.). The basics are that each financial transaction must have at least 1 debit and one credit entry and that the amount of the total debits must be equal to the total credits amount.
You debit assets and expense accounts when you increase them and you credit asset and expense accounts when you decrease them.
You do the opposite for debt and income accounts. You credit them when you increase them and you debit them when you decrease them.
You buy food with cash – Dt. Food expenses / Ct. Cash
You buy a computer with a loan – Dt. Asset (computer) / Cr. Debt (bank loans)
After these transactions are been booked, the accountants must do additional entries for closing the books and calculating your profit and your balance sheet. These closing procedures must be done because before closing expenses are somewhat positive and income is somewhat negative (You debit expenses and credit income).
Only after all of the above the accountant can do the job she/he is actually paid for – calculate your taxes.
You still do not get traditional accounting. Do not worry, you do not have to!!!
So the accountant mentality is to balance debits and credits. They feel satisfaction when they crunch your numbers and at the end everything balances perfectly. It will balance!
You, on the other hand, care most about your bottom line and balancing is not a big priority.
Traditional accounting thinking is close to some eastern religions like “yin and yang” where seemingly opposite or contrary forces may actually be complementary, interconnected, and interdependent in the natural world.
Balancing way of thinking, as spiritual as it might sound, can be static and misleading in domains (or systems) where the balance is dynamic and everchanging like a vortex. Balancing your accounts may differ from being broke to being rich. Sometime accountants may not see the difference.
Applying the wealth formula makes you see the difference each and every time you make a transaction. It requires some balancing but it keeps you on the right track following what matters.
Another great benefit of the wealth formula is that you do not have to close your books with additional entries to calculate your profit. You just sum your income and expenses and the residual is your profit. That’s it.
Sometimes accounting period closing is been done for pure computational reasons. If you have a lot of transactions summing your annual transactions with a summary of all your prior years’ transactions will lead to faster processing. With todays technologies and available CPU power this computational problem is not such a big hassle.
Just forget about using debits and credits and start applying the wealth formula.
ASSETS – DEBT = INCOME – EXPENSES = WEALTH