Accounting Theory

Jade Tree uses the Fundamental Accounting Equation (opens new window) and Double Entry Bookkeeping (opens new window) internally so that all transactions are tracked and can be verified for accuracy. The accounting equation implemented by Jade Tree is:

Assets - Liabilities = Capital + Income - Expenses = Net Worth

Account Types

Asset and Liability account types relate to the location of the money, where asset accounts represent money that the user posesses or is owed, and liability accounts represent money owed to other parties. User accounts (Checking, Savings, Credit Card, etc) are therefore either Asset or Liability accounts.

Capital, Income, and Expense account types relate to the purpose of the money, and are used internally by Jade Tree for budgeting. Each Budget has two Income accounts (for current month and next month) and one Expense account which holds all expenses related to the budget. Capital accounts are only used for account starting balances.

Note the signs in the Accounting Equation above. The signs are set so that most account balances will normally be positive. Liability and Expense accounts with a positive balance mean there is money owed to other parties (which is the point of those types of accounts).

WARNING

This is important to know when adding new Credit Card and other liability accounts. The Balance should be a positive number unless you have overpaid the account and have a credit. Most online bank sites display liability accounts this way, so copying and pasting should generally work.

Book Keeping

Notice there are two equal signs in the Accounting Equation above. This means there are two ways of calculating Net Worth (Assets - Liabilities and Capital + Income - Expenses), and we need them both to come up with the same answer! To make sure that happens, we use Double Entry Bookkeeping, meaning each Transaction (meaning the flow of money between two accounts) gets entered into each account that it touches.

If money flows between an asset account and an expense account (for example using a debit card to buy groceries), an entry is created in both accounts:

• the Asset account linked to the checking account gets an entry with a negative amount, meaning net worth goes down because we just spent money
• the Expense account linked to the budget gets an entry with a positive amount, meaning net worth goes down because we added an expense

The amounts of both entries will be the same as the transaction amount, so the change in net worth is the same whether we calculate it by Assets and Liabilities or Income and Expenses.

When money is transferred between two accounts (for example a credit card payment from a checking account), net worth does not change, but two entries are still created in the Asset and Liability accounts linked to the checking account and credit card, respectively.

Jade Tree's accounting subsystem can support complex transactions involving multiple accounts and currencies, and more detail can be found in the developer documentation, but the tenants here still hold for all of them.

Multiple Currencies

To support multiple currencies for a user's accounts, for example when budgeting in a local currency while using bank accounts in a foreign currency, Jade Tree implements a special Currency Trading account to handle transactions when the exchange rate can vary over time and cause the double-entry accounting method to become unbalanced.

For a specific example, consider a case where a user transfers US$100 from a US checking account into a savings account in Europe. The day the transfer is made, the exchange rate is US$1.00 = €0.80, and the savings account value grows by €80.00. A week later the exchange rate is now $1.00 = €0.75, so our transaction is now unbalanced since the original $100 no longer equals €80, as is recorded by the transaction line, but rather €75. Since double-entry accounting relies on both sides of the transaction balancing at all times, we have a data integrity problem.

One solution to this is splitting the transaction into two sub-transactions: one between the checking account and the Currency Trading account for $100, and one between the trading account and the savings account for €80. Each sub-transaction now balances at all times: €80 is always €80 no matter the exchange rate. While this may seem like overkill for a single transaction, it provides the flexibility to understand the unrealized loss (or gain) of all foreign exchange transactions in one number. This idea of a trading account can also be generalized to other variable-priced assets such as securities, although there is not currently support for that in Jade Tree.

A thorough discussion of the issue is presented by Peter Selinger (opens new window), which informed the development of the Jade Tree foreign currency model.