National Income and Product Accounts

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The National Income and Product Accounts (NIPA) are part of the national accounts of the
United States. They are produced by the Bureau of Economic Analysis of the Department of
Commerce. They are one of the main sources of data on general economic activity in the United
States. For, example, they are the source of the Gross Domstic Product (GDP) figure.
They use double-entry accounting to report the monetary value and sources of output produced
in the country and the distribution of incomes that production generates. Data are available at the
national and industry levels.
Seven summary accounts are published, as well as a much larger number of more specific
accounts. The first summary account shows gross domestic product and its major components.
The table summarizes national income on the left (debit, revenue) side and national product on
the right (credit, expense) side of a two-column accounting report. Thus the left side gives GDP
by the income method, and the right side gives GDP by the expenditure method. The GDP is
given on the bottom line of both sides of the report. GDP must have the same value on both sides
of the account. This is because income and expenditure are defined in a way that forces them to
be equal (see accounting identity). We show the 2003 table later in this article; we present the
left side first for convenient screen display.
The U.S. report (updated quarterly) is available in several forms, including interactive, from
links on the Bureau of Economic Analysis (BEA) NIPA ([1]) page. International norms for
national accounting methods are given by the United Nations System of National Accounts. The
NIPAs are prepared by the staff of the Directorate for National Economic Accounts within the
BEA. The source data largely originate from public sources, such as government surveys and
administrative data, and they are supplemented by data from private sources, such as data from
trade associations (BEA 2008: 1-6).
Contents
[hide]
1 Accounting for National Income: the left side of the report
1.1 Table 1: The revenue uses of GDP
1.2 Accounting for National Product: The Right Side of the Report
1.2.1 Table 2: Production sources of gross domestic GDP
1.3 Notes
2 See also
3 External links
[edit] Accounting for National Income: the left side of the report
The income side of the National Income and Product Account report begins with the kinds of
income people might have. Employee compensation includes the wages and salaries paid to
anyone whose income is subject to income tax withholding. Since wages and salaries affect more
individuals and families directly than the other sources of income, it has by far the largest value.
[edit] Table 1: The revenue uses of GDP
National Income and Product Accounts of the U.S.
[Billions of current US$]
Income Accounts 1 2003
2
Employee compensation 6,289.00
Proprietors' income with IVA and CCA 3 834.10
Rental income of persons with CCA 153.80
Corporate profits with IVA and CCA 4 1,021.10
Net interest and miscellaneous payments 543.00
Taxes on production and imports 798.10
Less: Subsidies -46.70
Business current transfer payments (net) 77.70
Current surplus of government enterprises 9.50
Equals: National Income (NI) 9,679.60
Statistical discrepancy 25.60
Equals: Net National Product (NNP) 9,705.20
Consumption of fixed capital 1,353.90
Equals: Gross National Product (GNP) 11,059.10
Income receipts from the rest of the world 273.90
Less: Income payments to the rest of the world -329.00
Equals: Gross domestic product (GDP) 5 11,004.00
=========
Proprietors' income is the payments to those who own non-corporate businesses, including sole
proprietors and partners. Inventory Value Adjustment (IVA) and Capital Consumption
Adjustment (CCA) are corrections for changes in the value of proprietor's inventory (goods that
may be sold within one year) and capital (goods like machines and buildings that are not
expected to be sold within one year) under rules set by the U.S. Internal Revenue Service (IRS).
Rental income of persons excludes rent paid to corporate real estate companies. Real estate is
capital rather than inventory by definition, so there is no IVA.
Corporate profits with IVA and CCA is like the entries for proprietors' income and rental income
except that the organization is a corporation. Corporate profit is shown before taxes, which are
part of Taxes on Production and imports, two lines down.
Business current transfer payments is not explained here.
Net interest and miscellaneous payments is interest paid minus interest received plus payments to
individuals and corporations that are not elsewhere classified (NEC). Taxes on production and
imports does not include corporate income tax payments to the states and to the federal
government. Taxes on production and imports were previously classifed as "indirect business
taxes" and include excise taxes, sales taxes, property taxes, and other taxes relating to business
production. While the report includes the net value of interest payments and receipts, both the
taxes paid and subsidies from the government are shown.
National Income (NI) is the sum of employees, proprietors, rental, corporate, interest, and
government income less the subsidies government pays to any of those groups.
Net National Product (NNP) is National Income plus or minus the statistical discrepancy that
accumulates when aggregating data from millions of individual reports. In this case, the
statistical discrepancy is US$25.6 billion, or about 0.23% of Gross Domestic Product. A
discrepancy that small (less than three-tenths of one percent) is immaterial under accounting
standards.
Gross National Product (GNP) is Net National Product plus an allowance for the consumption of
fixed capital, mostly buildings and machines, usually called depreciation. Capital is used up in
production but it does not vanish.
Finally, Gross Domestic Product (GDP) is Gross National Product plus payments from the rest
of the world that are income to residents of the U.S. minus payments from the U.S. to the rest of
the world that count as income where they are received.
[edit] Accounting for National Product: The Right Side of the Report
Macroeconomics defines GDP, from the production perspective, as the sum of personal
consumption, investment, net exports, and government expenditures; GDP = C + I + (X - M) +
G.
[edit] Table 2: Production sources of gross domestic GDP
National Income and Product Accounts of the U.S.
[Billions of current US$]
Product Accounts 1 2003
Durable goods 950.70
Nondurable goods 2,200.10
Services 4,610.10
Personal consumption expenditures 7,760.90
Nonresidential 1,094.70
Residential 572.30
Change in private inventories −1.20
Gross private domestic investment 1,665.80
Exports 1,046.20
Less: Imports −1,544.30
Net exports of goods and services −498.10
Federal 752.20
State and local 1,323.30
Government consumption expenditures
and gross investment 2,075.50
5
Gross domestic product (GDP) 11,004.10
=========
The production side report also begins with individuals and families, in this case their Personal
Consumption Expenditures on goods and services, C in the definition. Durable goods are
expected to last more than a year (furniture, appliances, cars, etc.) and to have little or no
secondary resale market. Nondurable goods are used up within a year (food, clothing,
medicine...). Services includes everything else, everything we buy that has little or no physical
presence, like banking, health care, insurance, movie tickets, and so on.
Gross private domestic investment includes expenditures on goods that are expected to be used
for an extended period of time, I in the definition. Residential investment includes owner
occupied and rental housing. Nonresidential investment includes buildings, machinery, and
equipment used for commercial or industrial purposes (small business, agriculture,
manufacturing, service, etc.). The last element of Investment accounts for any change in the
value of previous investments that are still in use, called inventory.
Net Exports reports the balance between goods produced domestically but consumed abroad (X)
and goods produced abroad but consumed domestically (M). There is no distinction between
consumption and investment or between the private and public sectors; a consumer's imported
television, a corporation's imported lab equipment, and the government's use of imported food on
military bases count equally. When Net Exports are positive, the country has a trade surplus.
When Net Exports are negative, there is a trade deficit.
Government Consumption Expenditures and Gross Investment includes all government
expenditures on domestically produced goods and services. Like an individual or family, the
government consumes food, clothing, furniture, and other goods and services in its
administrative, military, correctional, and other programs. Governments also invest in buildings
for program use and in improvements to harbors, rivers, roads, and airports. Transfer payments,
like subsidies to the unemployed or the retired, are not included in this item, since they are
simply a movement of money from government to citizens, rather than a purchase of goods or
services.
The sum of the four production categories is Gross Domestic Product, the value of all domestic
expenditures on goods and services. GDP (Income) must equal GDP (Production) except for any
rounding error that accumulates when the data used to prepare a table includes rounding at prior
stages of analysis, as appears to have happened in this case.
[edit] Notes
1
On 17 Sep 2004 the U.S. Bureau of Economic Analysis National Income and Product
Accounting (US BEA NIPA) web site was http://www.bea.doc.gov/bea/dn1.htm. At that time,
the tables cited here were downloaded as a wk1 format spreadsheet in a zip file through a button
on that page.
The BEA's table and line numbers were removed for clarity and the sums were recalculated. Copies of the
downloaded BEA NIPA tables used to construct the example, including table and line numbers, are in a
pdf file. The BEA offers the NIPA tables interactively and as txt, zipped wk1, exe, csv, and pdf files.
Footnotes to the BEA's tables are available in their pdf file only. The downloads include the two most
recent annual values and the five most recent quarterly values for each item. The quarterly values are
seasonally adjusted at annual rates; they do not add to a reported annual value. The income side of the
report is derived from BEA NIPA Tables 1.7.5 (Relation of Gross Domestic Product, Gross National
Product, Net National Product, National Income, and Personal Income) and 1.12 (National Income by
Type of Income). The production side of the report is derived from BEA NIPA Table 1.1.5 (Gross
Domestic Product). There is a 0.1 (US$100M or 0.00091%) rounding error from the official GDP
(11,004.0) in the recalculated sum on the Product Accounts side.
2
Employee compensation includes wages and salaries plus employer payments for government
insurance and pension programs.
3
IVA refers to Inventory Valuation Adjustment and CCA refers to Capital Consumption
Adjustment; they are features of U.S. tax law.
4
Corporate profits reported here are before taxes. They are divided among Tax payments
(234.90), Net dividends (395.30), and Undistributed profits (also known as Retained Earnings)
(390.90).
5 GDP includes all goods and services produced within a country.

National Income Accounting

The statistics for Gross Domestic Product (GDP) are computed as part of the National Income
and Product Accounts. This national accounting system, developed during the 1940s and 1950s,
is the most ambitious collection of economic data by the United States government and is the
source of much of the information we have about the economy. Like business accounting,
national-income accounting uses a double-entry approach. Because each transaction has two
sides, involving both a sale and a purchase, there are two ways to divide up GDP. One can look
at the expenditures for output, or one can look at the incomes that the production of output
generates.

Let us look at how this double-entry system works. Suppose you are a computer programmer
who creates a game that you distribute over the internet. You have no costs of packaging--you
only input is your skill and time as a programmer. Lots of teenagers buy your game and you earn
$50,000 dollars for the year. You have produced something of value. How should we account for
this production?

The double-entry system says that the expenditures made on the product, which is the source of
funds to the producer, should equal the uses of funds by the producer, which are the incomes that
flow from production. Because ordinary people bought this game, the expenditures made are by
households. They are called consumption expenditures. We will increase them by $50,000. You
pay yourself, but is what you earn wages or profit? For an unincorporated business there is a
special category for earnings called proprietors' income, and it will increase by $50,000

Expenditures Made on Output Incomes Generated in Production

(Source of Funds) (Uses of Funds)
Consumption $50000 Proprietors' Income $50000

Suppose instead that you incorporate yourself as a business and your product is educational
software sold only to public schools. What will change? The expenditures are no longer
consumption because they are not made by the household sector. There are three other sectors of
the economy used in national income accounting: government, business, and the rest of the
world. Public schools are an important part of the government, so now these sales will be
classified as government expenditures. Since you are incorporated, you will have to file a tax
form that separates wages from your profit. Suppose you tell the IRS that you paid yourself
$40,000 and that the profit of your business was $10,000. On the Income side of the accounts,
employee compensation goes up $40,000 and corporate profits goes up $10,000.

Expenditures Made on Output Incomes Generated in Production

(Source of Funds) (Uses of Funds)
Employee Compensation $40000
Government Spending $50000
Corporate Profit $10000

Finally, suppose you retire and receive $15,000 per year from Social Security. What will we do
in this case? The answer is, "Nothing," because nothing has been produced. This income is a
transfer payment. It was taken from someone through taxes (euphemistically called a
contribution in the case of Social Security, but there was nothing voluntary about it) and given to
you. In an exchange, both parties must give to get. In a transfer, one party gives and the other
gets--no service or product is returned to the giving party.

Now that we have seen the logic behind these accounts, let us see what they look like in a bit
more detail.
 Who Gets GDP?
The national income and product accounts have four groups that use production. The table below
shows that in the United States the largest amount goes to ordinary people and is classified as
consumption. The food, the clothes, the medical check up, and the gasoline you buy are all
consumption expenditures. The next largest use of output is by the government, including state
and local governments in addition to the federal government. This category of government
spending includes items such as purchases of military goods, payments to public school teachers,
and the salary of your congressman. It may surprise you that in 1990 the expenditures of state
and local governments were larger than those of the federal government: $673.0 million for the
former and $508.4 for the latter. Not included as government expenditures are payments for
which no service is expected, such as payment of social security to the elderly. This sort of
transaction is classified as a transfer.

U.S. Gross Domestic Product, Selected Years

(Numbers in billions of dollars)

. 1933 1960 1990
GDP 56.4 527.4 5803.2
Consumption 45.9 332.3 3831.5
Government Spending 8.7 113.8 1181.4
Investment 1.7 78.9 861.7
Net Exports .1 2.4 -71.4
.
Sources: Survey of Current Business, August 2001;
<www.bea.gov/bea/dn/nipaweb/TableViewFixed.asp>, Tables 1.1,
1.9 and 1.14.

The third category, investment, includes construction of new factories and the purchase of new
machines by businesses. It also includes changes in inventories held by business and the
purchase of new homes by consumers. New homes are considered investment spending because
they are a long-lived assets that will yield services for many years. On the other hand, purchases
of appliances and vehicles by consumers are considered consumption, though these items also
have lifetimes much longer than a year. The dividing line between investment and consumption
is not clear-cut and sometimes shifts. At one time the purchase of a mobile home was classified
as consumption, but it is now classified as investment.

The use of the word "investment" in discussing GDP differs from the use of this word in every
day speech. People talk about investing in stocks and bonds, for example, yet purchases of stocks
and bonds are not considered investment for purposes of computing GDP. In fact, these
transactions are not counted at all because they involve the exchange of existing or new financial
instruments, not the purchases of actual output. If you loan a company money by buying a
newly-issued bond, investment will be affected only if the company uses your money to
purchase new capital or to increase inventory. Differences in the way economists use words and
the way they are used in everyday conversation are common.

The last group that receives the output that our economy produces is foreigners. To take this
group into account, we must add exports to consumption, investment, and government spending.
However, some consumption, investment, and government spending is for goods that are
produced in other countries, not here. One way to account for these purchases of foreign
products would be to adjust consumption, etc. so that they included only the amounts spent on
domestic products. However, this is not the way imports are taken into account. They are
subtracted from exports to obtain net exports. A reason for this procedure is that data for
imports as a whole is more reliable than data broken into imported consumption expenditures,
imported investment expenditures, and imported government expenditures.

The small numbers for net exports in the table disguises the importance of foreign transactions.
In 1990 exports were $557.2 billion, or about ten per cent of total production, and imports were
$628.6 billion. Because they were similar in size, their difference, net exports, was fairly small.

We can summarize our discussion so far in terms of an equation that you will see again:

(1) GDP = C + I + G + Xn

As the table indicates, we can break apart GDP by the income flows to which the production
gives rise.

Incomes from GDP

The alternative way to break down GDP is to consider the incomes that production of output
generates. The largest of these is in the form of employee compensation. The major part of this
category is pre-tax wages and salaries, but it also includes employers' payments into the Social
Security program and some other items. As the table indicates, compensation of employees has
always been the largest type of income that is generated in production.

A second, obvious item in computing GDP by looking at incomes is corporate profit. Corporate
profit includes the amounts that corporations pay in the form of the corporate income tax, the
amounts they pay stockholders in the form of dividends, and the amounts they "save" or retain
within the business.

The category proprietors' income captures a class of income that falls between wages or salaries
and profits. It is the amount that those who are in business for themselves, but who have not
incorporated their businesses, earn. The amount that the owner of a cafe or a farm earns in a year
is often considered by the owner of the business as a "profit," yet most of that "profit" is a
payment to the owner for his labor. Because it is difficult or impossible to separate the part of
this income that is truly a wage to the owner from that which is actually a profit, the folks at the
Commerce Department who collect the numbers keep it in the separate account of proprietors'
income.
 U.S. Gross Domestic Product, Selected Years

(Numbers in billions of dollars)

. 1933 1960 1990

Compensation of Employees 29.6 296.4 3351.0

Corporate Profits -.3 52.3 408.6
Proprietors' Income 5.8 51.9 381.0
Rental Income 2.5 16.2 49.1
Net Interest 3.9 10.7 452.4
National Income 41.4 427.5 4642.1
Indirect Business Taxes and Misc. 7.0 46.1 478.8
Net National Income 49.5 473.6 5120.9
Capital Consumption Allowance 7.7 56.9 711.3
Gross National Product 56.7 530.6 5832.2
(Net Factor Income from Abroad) (.3) (3.2) (29.0)
GDP 56.4 527.4 5803.2
.
Sources: Survey of Current Business, August 2001;
<www.bea.gov/bea/dn/nipaweb/TableViewFixed.asp>, Tables 1.1,
1.9 and 1.14.

The major part of rental payments to persons is in the form of imputed rent of owner-occupied
housing. Imputed rent estimates how much rent people who own their homes would pay if they
had to pay rent, and assumes that they then pay this amount to themselves. This is the major class
of non-market production that GDP includes. The production that housewives contribute in the
home is not counted, crops grown for home use in a vegetable garden are not counted, and home
repairs that a person does for himself are not counted. In all these cases there is production of
goods or services and these goods and services could be purchased in the market. They are not
included because estimating their value is too difficult. The Commerce Department does not
believe that it is as difficult to estimate the services that a home provides, so does count the value
of these services. Also included in rent are royalties and income that comes from the ownership
of patents.

The payment of interest includes interest that businesses pay as part of the expense of operating
less the amounts businesses receive as interest. Thus this category includes only interest that the
business sector as a whole pays out. This category does not include the interest that consumers
pay because it is not considered as a payment stemming from the production of output, nor does
it include interest that the government pays on its debt. Government interest payments are seen
as transfers because no output is produced that the interest supports. In contrast, when General
Motors pays interest, this interest is a payment for funds used to purchase machines or other
assets necessary to carry on the business.
Adding up these five categories give us National Income, the income that resources earn in the
process of production. However, there are additional payments made. Though no services are
rendered for it, there is another class of "income" to which production gives rise. This is the class
of indirect business taxes, the most important parts of which are sales and excise taxes. This
item must be included to make the expenditure or use side equal the income side. A sales tax
causes the amount that consumers pay to exceed the amount that businesses receive. Although
not a true income because it is not a payment for services, it is part of the value of final output.
Adding indirect business taxes and several small items, we arrive at Net National Product or
NNP.

The biggest difference between NNP and GDP is Capital Consumption Allowance, which is a
measure of depreciation. In the course of producing goods and services, some of the existing
capital stock is used up. Factories, trucks, computers, and drill presses all have limited lives, and
the use of these items uses up some of their lives and thus their value. The concept of
depreciation can be explained by a simple example. Suppose a farmer plants 100 bushels of seed
and harvests 10000 bushels. His gross harvest is 10000 bushels, but his net harvest is only 9900.
If he had planted nothing, he would have had 100 bushels of grain, so he gains only 9900. Part of
his cost is the using up of 100 bushels of seed.

You might at this point decide that a better measure of what the economy produces would be to
subtract the capital consumption allowances from GDP and use the net figure. While the NDP
does make more sense as a measure of the economy's output, economists prefer not to use it
because the capital consumption allowance is less reliable than the data used to calculate GDP.
Since NNP is computed by subtracting the capital consumption allowances from GDP, it will be
a less reliable number than GDP. In addition, depreciation is not as quickly available as are the
rest of the data needed to give a good estimate of GDP, so NNP numbers are announced later
than GDP figures. In the tradeoff between reliability and theoretical attractiveness, economists
have chosen reliability.

Adding the capital consumption allowance to NNP gives Gross National Product or GNP. It
differs from GDP because GDP measures the production that occurs within the national
boundaries while GNP measures the production attributable to the people who live within those
boundaries. If a person in the United States owns a profitable factory in Mexico, the profit counts
in US GNP but not in US GDP. To get to GDP we subtract from GNP Net Factor Incomes
from Abroad. This item includes payments to Americans who own resources in the rest of the
world less payments to foreigners who own resources in the United States.

If you want more details of these data, you need to go to the source, which is what you will be
asked to do it you click the Explore button below.

We have gone from GDP to National Income, but the economists who put together the GDP
figures know how to break it down into a whole lot of other categories.

More National Income Accounting

GDP data are important by themselves. However, by deriving a series of other measurements,
one can compute how much of GDP is left as spendable income in the private and government
sectors, which allows one to construct a "budget constraint" for the economy as a whole.

To get from National Income to Disposable Income (DI), which is the income that people can
either spend or save, a number of adjustments must be made. First, that part of corporate profits
that never reaches households, retained earnings and corporate taxes, must be deducted. Next,
adjustments must be made in interest so that it includes only and all interest payments reaching
households. Then, payments to the government for social security and related programs must be
subtracted, and transfer payments from the government for these programs and other programs
must be included. Finally, business transfer payments, which include donations to non-profit
organizations and the write-off of bad debt, are added. This gives what is called Personal
Income. Some of Personal Income must be paid as taxes. What is left, Disposable Income, is
either spent or saved.

There is a point to all these computations. In deriving disposable income from GDP, we
separated amounts flowing to households from the rest of GDP. In the process, we can see where
the rest goes. Some stays in the business sector as business savings. Retained earnings and
depreciation are important parts of this sum. Some income ended up with the government. The
amount left in the government is the total of taxes less all transfers. Finally, somewhat lost in the
numbers are some transactions involving foreigners. They pay us interest, we pay them interest,
and there are also transfers in the form of aid. Let us call this total "Foreign Transfers (Tf).

This separation allows us to write GDP in a way that shows how much each sector (household,
business, government, and foreign) is left with:

(2) GDP = DI + Business savings + (Taxes - Transfers) + Tf

Disposable income is either consumed (C) or saved (S). If savings by households is combined
with business savings to get savings by the private sector (S), equation 2 can be written:

(3) GDP = C + S + (Taxes - Transfers) + Tf

Since equations 1 and 3 are both ways of arriving at GDP, we can combine them as:

(4) C + I + G + Xn = C + S + (Taxes - Transfers) + Tf

Reorganizing, and letting consumption cancel from both sides, gives:

(5) (I - S) + (G + Transfers - Taxes) + (Xn - Tf) = 0.

Equation 5 is a constraint that the economy as a whole faces. It may not mean a great deal to
you when you first look at it, but in fact it is an important equation. Consider what the contents
of each set of parentheses mean. The first term tells us about the private sector. If investment is
greater than savings, the private sector must borrow to finance the extra investment. If savings is
greater than investment, the private sector will lend to other sectors.
The middle term, (G+Transfers-Taxes) is the government deficit or surplus. Total government
expenditures equal its purchase of goods and services plus its transfers. If these are larger than
tax receipts, the government has a deficit, and must borrow to cover it.

The last term indicates the borrowing or lending of foreigners to finance foreign trade. When
foreigners buy from us, they must have a source of funds. One source is selling to us. If they sell
less than they buy, they must borrow the difference from us. If we buy more from them than we
sell to them, we must borrow the difference from them.

We have arrived at a simple result in a complex way. In any market the purchases of buyers must
equal the sales of sellers. Equation 5 shows this for the market for loanable funds. If someone
borrows $100, then someone else must lend $100. Equation 5 divides up all transactors in this
market into three groups, the private sector, the government, and the foreign sector and says that
not all sectors can borrow at the same time. When one borrows, another must be lending.
Financial markets link the decisions of people who may have no idea that their decisions are in
fact connected.

The table below puts some numbers from the U.S. economy into this equation. Notice how
dramatically foreign borrowing changed in just two years. In 1984 the United States had a huge
deficit in its balance of trade--it bought much more from foreigners than it sold to them. The
table says that the dollars that foreigners earned on these sales were returned to the U.S.
government and businesses in the form of foreign loans.

The U.S. Budget Constraint

. 1982 1984
Investment - Savings -109.1 -37.0
Government Deficit 115.3 122.9
Foreign Borrowing -6.6 -93.4
Statistical Discrepancy .5 7.5
Sources: Survey of Current Business, Nov. 1984,
1985. Amounts are in billions of dollars; a
negative represents lending to credit markets and
a positive represents borrowing. The "statistical
discrepancy" occurs because there are errors in
measuring the components.

It would be nice if the table could tell us why the large amount of foreign lending to the U.S.
suddenly occurred. However, neither the table nor the equation on which it is based can do that.
They simply tell us that there are connections among the sectors of the economy. If the
government sector runs a larger deficit, for example, other sectors must finance the deficit and
thus they will be affected. Although the equation clearly shows that a change in the government's
deficit will affect other sectors, it does not tell us what the effects will be. For this we need
economic theory, and in this we do not find consensus among economists. On one hand,
Keynesian economists (those who draw inspiration from the writings of John Maynard Keynes)
have argued that an increased deficit may increase savings by more than the increased deficit,
and thus actually increase investment. On the other hand, non-Keynesians have usually argued
that the increased deficit will have little effect on savings and will crowd out investment.
Explaining these theories is the major task of a course in macroeconomics.

We have saved the best for last. There is another way to see the interconnections among sectors.

Aggregating Markets and Sectors

Aggregating, that is, adding together items to make a whole, is commonplace in economics. The
notions of supply and demand, for example, depend on the aggregation or adding together of the
demands of many individual buyers and the supplies of many individual sellers. Although all of
economics uses aggregation, the amount of aggregation is much greater in macroeconomics than
in microeconomics.

The whole process of aggregation involves conceptual problems and ambiguities, but the
simplification that aggregation can introduce can more than pay for the problems involved. To
illustrate the problems involved in aggregation, consider a discussion of the supply and demand
for apples. In such a discussion, one has made a decision that certain items should be considered
together--yellow and red apples, winter and fall apples, eating apples and cooking apples. When
one discusses the "apple market," one implicitly assumes that the differences among the various
varieties of apples are small enough to ignore for the purposes at hand, but the differences
between apples and pears, very similar fruit, are too large.

For some purposes one might want to aggregate more and speak of the "fruit market" rather than
the "apple market." Further aggregation would lead to the food market. At this level of
aggregation, one is not only adding apples and oranges together, but also apples and beefsteak.
Although this may seem like aggregation gone wild, macroeconomists customarily aggregate a
great deal more. They discuss the market of goods and services, the labor market, and the
financial market. The advantage of this drastic aggregation is that it simplifies the workings of
the system to the point at which the human mind can begin to understand it.

Aggregation allows one to use the insights of Say's and Walras' Laws to discuss conditions of
equilibrium. Our economy is more complex than the simple economy of Crusoe, Friday, and
Saturday. Not only do we trade many thousands of goods and services, but we also exchange a
complex array of debts and assets. Further, most people are not craftsmen or farmers producing
and selling products, but are employees who sell their labor services in one of the many labor
markets of the economy.

The central idea Say's Law is that if people plan or expect to receive a certain amount of income,
they also have planned or expected uses. Thus a change in one market (such as the market for
high school science teachers) will have affects in other markets (such as the markets for food and
clothing). But tracing these effects from market to market is beyond the power of the human
mind if we attempt to view the economy as made up of many thousands of markets. The solution
has been to aggregate and create "composite" goods, so that we can picture the economy as made
up of only a few markets.
There is no magic formula for the "right" amount of, or way to aggregate. Some theories imply a
drastic aggregation to just two markets--we will see that both the quantity theory of money and
the Keynesian multiplier model imply an aggregation to just two markets. However, economists
usually prefer less aggregation. In modern market economies households do not barter but buy
goods and services with money. Households have three ways to obtain the funds they use to
finance these purchases. They can earn income by selling the services of their labor or other
resources, they can borrow money or dissave, and they can reduce money balances. Usually the
way economists aggregate reflects this list of sources and uses of funds.

The table below shows a way of aggregating that is useful for many discussions of
macroeconomics. In this table all the millions of buyers and sellers have been grouped into only
three categories: those in the private sector, the government, and the foreign sector. Often less
aggregation is needed in the private sector. It can be separated into households and businesses,
and sometimes the banking sector is split away from the rest of the business sector.

Expected Sources and Uses of Funds

. Private Sector Government Sector Foreign Sector
Goods and Services . . .
Labor (and Resources) . . .
Money . . .
Financial . . .

The markets in which people exchange have also been reduced in number, to a mere four. All
goods and services are grouped together, and all labor markets and other resource markets are
consolidated. All financial transactions, involving the purchase and sale of securities, are
combined to form the financial market. Finally, to include the possibility both of changes in the
amount of money circulating and the amount that people want to hold, a market for money
balances is included.

There are no numbers included in the table. Entries are of planned or expected amounts, and
there is no way of knowing these. The problems involved can be understood if one looks back to
the supply and demand model. If a market is not in equilibrium, the desired amounts that buyers
and sellers want to exchange are not equal, but the actual amounts that they do exchange are
equal. Actual amounts can be observed, but they do not indicate if the market is or is not in
equilibrium. Desired amounts, which would tell one whether or not the market was in
equilibrium, cannot be directly observed. Thus, although one can get estimates of the actual
amounts in each category in the table, they do not help in seeing which markets have excess
supply and which have excess demand.

The table does, however, illustrate in a more general way the connections between sectors of the
economy than does the approach of national income accounting, and can in fact show equation 5
of that discussion:

(5) (I - S) + (G + Transfers - Taxes) + (Xn - Tf) = 0.

To show equation 5, combine the goods and resources markets and consolidate the money
market with the bond market. These changes plus a switch to actual transactions from planned
transactions give us the table below. The actual (not planned) excess demand in the nonfinancial
markets for the private sector is investment minus savings, for the government it is government
expenditures minus taxes, and for the foreign sector it is net exports less foreign transfers.
Because the actual values of these items are included, they must sum to zero both horizontally
and vertically. The table indicates that excess demands in the nonfinancial markets will yield
excess supplies in the financial markets, and vice versa.

Actual Sources and Uses of Funds

. Private Sector Government Sector Foreign Sector
Nonfinancial Markets I-S G + Tn - TX Xn-Tf
Financial Markets S-I TX - G - Tn Tf-Xn

We end these readings with a claim that we are headed on the wrong path.

Real-Business Cycles
Mainstream macroeconomists view recessions as a case of market failure. There are workers
who would like to work but cannot because no one is willing to hire them. Their lack of income
creates consumers who would like to spend but who cannot because they do not have the funds
to do so. As a result, there are businesses that would like to produce and hire more workers, but
cannot because there is not enough demand for final output. The circle is complete, and there is
something not working properly.

The traditional explanation for this situation was a failure of wages and prices to adjust quickly
enough. A change in spending drives the economy away from equilibrium, but sticky wages
and/or prices prevent rapid adjustment to a new equilibrium. Because wages and prices do not
adjust, output does.

There is a group in macroeconomics--known by several names, including real-business cycle

theorists--that tosses out the above explanation and begins by assuming that markets always
clear. If a market does not clear, there is a profit opportunity for someone, and someone will take
it. Hence wages and prices should not be sticky, but should adjust quickly.

If markets are always in equilibrium, then how do we explain the fluctuations in business activity
that have been obvious for over two centuries? The real-business cycle theorists say that an
important cause is fluctuation in the rate of technology change. Suppose, for example, the rate of
technology slows down. As a result, people's marginal productivity will drop, and as it does, the
real wage will drop. People will react to that change in real wage in a rational manner by shifting
their work and leisure decisions over time.

Suppose that in some weeks you get paid $15 per hour, and in other weeks you only get paid $5
per hour. If you can work as many hours per week as you want, what kind of pattern will there be
to your work? Although some people undoubtedly would work the same in all weeks, most
people would work longer in the higher-pay weeks and less in the lower-pay weeks. They will
take their leisure in the lower-pay periods, and move their work to the higher pay periods.

The real-business cycle suggests that this same pattern holds over longer periods. When there is a
technological shock raising real wage, people will work more causing output to surge, and when
there is a technological shock lowering real wage, people will withdraw from work, causing
output to fall. This pattern is what we observe as booms and recessions.

Many economists find the real-business cycle theory totally unbelievable. No one can observe
the technological shocks that are at the heart of this explanation, and it strikes many as simply
ridiculous to argue that the unemployment during a recession is voluntary. On the other hand, the
economists who have formed these arguments are among the brightest of the profession, and
they can show that the patterns that their mathematical models generate are remarkably similar to
the patterns that the real world generates.

The studies on the real-business cycle do show that alternative explanations to the patterns we
observe are possible and are a reminder of how little we know for certain in macroeconomics. It
may be that this line of inquiry will result in drastic alternations in the way economists view
macroeconomics (rendering much of the material in these pages obsolete), but it is also possible
that the whole approach may eventually prove to be one more dead end in the study of
economics.

Measures of national income and output

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A variety of measures of national income and output are used in economics to estimate total
economic activity in a country or region, including gross domestic product (GDP), gross national
product (GNP), and net national income (NNI). All are specially concerned with counting the
total amount of goods and services produced within some "boundary". The boundary may be
defined climatologically, or by citizenship; and limits on the type of activity also form part of the
conceptual boundary; for instance, these measures are for the most part limited to counting goods
and services that are exchanged for money: production not for sale but for barter, for one's own
personal use, or for one's family, is largely left out of these measures, although some attempts are
made to include some of those kinds of production by imputing monetary values to them. [1]

As can be imagined, arriving at a figure for the total production of goods and services in a large
region like a country entails an enormous amount of data-collection and calculation. Although
some attempts were made to estimate national incomes as long ago as the 17th century,[2] the
systematic keeping of national accounts, of which these figures are a part, only began in the
1930s, in the United States and some European countries. The impetus for that major statistical
effort was the Great Depression and the rise of Keynsian economics, which prescribed a greater
role for the government in managing an economy, and made it necessary for governments to
obtain accurate information so that their interventions into the economy could proceed as much
as possible from a basis of fact.

In order to count a good or service it is necessary to assign some value to it. The value that all of
the measures discussed here assign to a good or service is its market value – the price it fetches
when bought or sold. No attempt is made to estimate the actual usefulness of a product – its use-
value – assuming that to be any different from its market value.

Three strategies have been used to obtain the market values of all the goods and services
produced: the product (or output) method, the expenditure method, and the income method. The
product method looks at the economy on an industry-by-industry basis. The total output of the
economy is the sum of the outputs of every industry. However, since an output of one industry
may be used by another industry and become part of the output of that second industry, to avoid
counting the item twice we use, not the value output by each industry, but the value-added; that
is, the difference between the value of what it puts out and what it takes in. The total value
produced by the economy is the sum of the values-added by every industry.

The expenditure method is based on the idea that all products are bought by somebody or some
organisation. Therefore we sum up the total amount of money people and organisations spend in
buying things. This amount must equal the value of everything produced. Usually expenditures
by private individuals, expenditures by businesses, and expenditures by government are
calculated separately and then summed to give the total expenditure. Also, a correction term
must be introduced to account for imports and exports outside the boundary.

The income method works by summing the incomes of all producers within the boundary. Since
what they are paid is just the market value of their product, their total income must be the total
value of the product. Wages, proprieter's incomes, and corporate profits are the major
subdivisions of income.

The names of all of the measures discussed here consist of one of the words "Gross" or "Net",
followed by one of the words "National" or "Domestic", followed by one of the words "Product",
"Income", or "Expenditure". All of these terms can be explained separately.

"Gross" means total product, regardless of the use to which it is subsequently put.
 "Net" means "Gross" minus the amont that must be used to offset depreciation – ie.,
wear-and-tear or obsolescence of the nation's fixed capital assets. "Net" gives an
indication of how much product is actually available for consumption or new investment.
"Domestic" means the boundary is geographical: we are counting all goods and services
produced within the country's borders, regardless of by whom.
"National" means the boundary is defined by citizenship (nationality). We count all goods
and services produced by the nationals of the country (or businesses owned by them)
regardless of where that production physically takes place.
The output of a French-owned cotton factory in Senegal counts as part of the Domestic
figures for Senegal, but the National figures of France.
"Product", "Income", and "Expenditure" refer to the three counting methodologies
explained earlier: the product, income, and expenditure approaches. However the terms
are used loosely.
"Product" is the general term, often used when any of the three approaches was actually
used. Sometimes the word "Product" is used and then some additional symbol or phrase
to indicate the methodology; so, for instance, we get "Gross Domestic Product by
income", "GDP (income)", "GDP(I)", and similar constructions.
"Income" specifically means that the income approach was used.
"Expenditure" specifically means that the expenditure approach was used.

Note that all three counting methods should in theory give the same final figure. However, in
practice minor differences are obtained from the three methods for several reasons, including
changes in inventory levels and errors in the statistics. One problem for instance is that goods in
inventory have been produced (therefore included in Product), but not yet sold (therefore not yet
included in Expenditure). Similar timing issues can also cause a slight discrepancy between the
value of goods produced (Product) and the payments to the factors that produced the goods
(Income), particularly if inputs are purchased on credit, and also because wages are collected
often after a period of production.

Contents
[hide]

• 1 General
• 2 The output approach
• 3 The income approach
• 4 The expenditure approach
• 5 National income and welfare

• 6 References

[edit] General
Gross domestic product (GDP) is defined as the "value of all final goods and services produced
in a country in 1 year".[3]
Gross National Product (GNP) is defined as the market value of all goods and services
produced in one year by labour and property supplied by the residents of a country.[4]

As an example, the table below shows some GDP and GNP, and NNI data for the United States:
[5]

National income and output (Billions of dollars)

Period Ending 2003

Gross national product 11,063.3

Net U.S. income receipts from rest of the world 55.2

U.S. income receipts 329.1

U.S. income payments -273.9

Gross domestic product 11,008.1

Private consumption of fixed capital 1,135.9

Government consumption of fixed capital 218.1

Statistical discrepancy 25.6

National Income 9,679.7

• NDP: Net domestic product is defined as "gross domestic product (GDP) minus
depreciation of capital",[6] similar to NNP.
• GDP per capita: Gross domestic product per capita is the mean value of the output
produced per person, which is also the mean income.
[edit] The output approach
The output approach focuses on finding the total output of a nation by directly finding the total
value of all goods and services a nation produces.

Because of the complication of the multiple stages in the production of a good or service, only
the final value of a good or service is included in total output. This avoids an issue often called
'double counting', wherein the total value of a good is included several times in national output,
by counting it repeatedly in several stages of production. In the example of meat production, the
value of the good from the farm may be $10, then $30 from the butchers, and then $60 from the
supermarket. The value that should be included in final national output should be $60, not the
sum of all those numbers, $100. The values added at each stage of production over the previous
stage are respectively $10, $20, and $30. Their sum gives an alternative way of calculating the
value of final output.

Formulae:

GDP(gross domestic product) at market price = value of output in an economy in a particular

year - intermediate consumption

NNP at factor cost = GDP at market price - depreciation + NFIA (net factor income from
abroad) - net indirect taxes[7]

[edit] The income approach

The income approach focuses on finding the total output of a nation by finding the total income
received by the factors of production owned by that nation.

The main types of income that are included in this approach are rent (the money paid to owners
of land), salaries and wages (the money paid to workers who are involved in the production
process, and those who provide the natural resources), interest (the money paid for the use of
man-made resources, such as machines used in production), and profit (the money gained by the
entrepreneur - the businessman who combines these resources to produce a good or service).

Formulae:

NDP at factor cost = compensation of employee + operating surplus + mixed income of self
employee

National income = NDP at factor cost + NFIA (net factor income from abroad) - Depreciation

[edit] The expenditure approach

The expenditure approach is basically a socialist output accounting method. It focuses on
finding the total output of a nation by finding the total amount of money spent. This is
acceptable, because like income, the total value of all goods is equal to the total amount of
money spent on goods. The basic formula for domestic output combines all the different areas in
which money is spent within the region, and then combining them to find the total output.

GDP = C + I + G + (X - M)

Where:
C = household consumption expenditures / personal consumption expenditures
I = gross private domestic investment
G = government consumption and gross investment expenditures
X = gross exports of goods and services
M = gross imports of goods and services

Note: (X - M) is often written as XN, which stands for "net exports"

[edit] National income and welfare

GDP per capita (per person) is often used as a measure of a person's welfare. Countries with
higher GDP may be more likely to also score highly on other measures of welfare, such as life
expectancy. However, there are serious limitations to the usefulness of GDP as a measure of
welfare:

• Measures of GDP typically exclude unpaid economic activity, most importantly domestic
work such as childcare. This leads to distortions; for example, a paid nanny's income
contributes to GDP, but an unpaid parent's time spent caring for children will not, even
though they are both carrying out the same economic activity.
• GDP takes no account of the inputs used to produce the output. For example, if everyone
worked for twice the number of hours, then GDP might roughly double, but this does not
necessarily mean that workers are better off as they would have less leisure time.
Similarly, the impact of economic activity on the environment is not measured in
calculating GDP.
• Comparison of GDP from one country to another may be distorted by movements in
exchange rates. Measuring national income at purchasing power parity may overcome
this problem at the risk of overvaluing basic goods and services, for example subsistence
farming.
• GDP does not measure factors that affect quality of life, such as the quality of the
environment (as distinct from the input value) and security from crime. This leads to
distortions - for example, spending on cleaning up an oil spill is included in GDP, but the
negative impact of the spill on well-being (e.g. loss of clean beaches) is not measured.
• GDP is the mean (average) wealth rather than median (middle-point) wealth. Countries
with a skewed income distribution may have a relatively high per-capita GDP while the
majority of its citizens have a relatively low level of income, due to concentration of
wealth in the hands of a small fraction of the population. See Gini coefficient.
Because of this, other measures of welfare such as the Human Development Index (HDI), Index
of Sustainable Economic Welfare (ISEW), Genuine Progress Indicator (GPI), gross national
happiness (GNH), and sustainable national income (SNI) are used.

[edit] References
1. ^ Australian Bureau of Statistics, Concepts, Sources and Methods, Chap. 4, "Economic concepts
and the national accounts", "Production", "The production boundary". Retrieved November 2009.
2. ^ Eg., William Petty (1665), Gregory King (1688); and, in France, Boisguillebert and Vauban.
Australia's National Accounts: Concepts, Sources and Methods, 2000. Chapter 1; heading: Brief
history of economic accounts (retrieved November 2009).
3. ^ Australian Council of Trade Unions, APHEDA, Glosssary, accessed November 2009.
4. ^ United States, of the United States], p 5; retrieved November 2009.
5. ^ U.S Federal Reserve, the link appears to be dead as of late 2009
6. ^ Penn State Glossary
7. ^ NFIA meaning - Acronym Attic

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Net national income

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"Who receive the national income?" A 1950 Soviet poster.

Net national income (NNI) is an economics term used in national income accounting. It can be
defined as the net national product (NNP) minus indirect taxes. Net national income
encompasses the income of households, businesses, and the government.

It can be expressed as:

NNI = C + I + G + (NX) + net foreign factor income - indirect taxes - depreciation

where:

• C = Consumption
• I = Investments
• G = Government spending
• NX = net exports (exports minus imports)

This formula uses the expenditure method of national income accounting.

[edit] See also

• Gross national income

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National accounts
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National accounts or national account systems (NAS) provide a complete and consistent
conceptual framework for measuring the economic activity of a nation (or other geographic area
in the broader term social accounts). These include detailed underlying measures that rely on
double-entry accounting. By construction such accounting makes the totals on both sides of an
account equal even though they each measure different characteristics (Ruggles, 1987). While
sharing many common principles with business accounting, national accounts are firmly based
on economic concepts.
National accounts broadly present the production, income and expenditure activities of the
economic actors (corporations, government, households) in an economy, including their relations
with other countries' economies, and their wealth. They present both flows during a period and
stocks at the end of a period, ensuring that the flows are fully reconciled with the stocks.
National accounts also include measures of the stocks and flows of financial assets and liabilities
(commonly called "financial accounts" or "flow of funds" accounts).

There are a number of aggregate measures in the national accounts, most notably gross domestic
product or GDP - which is the most widely used measure of aggregate economic activity in a
period - disposable income, saving and investment. These aggregate measures and their
development over time are generally of strongest interest to economic policymakers, although
the detailed national accounts contain a rich source of information for economic analysis, for
example in the input-output tables which show how industries interact with each other in the
production process.

For example, in the United States the national income and product accounts (NIPA) provide
estimates for the money value of income and output respectively per year or quarter, including
GDP. NIPA entries are called flows, to indicate that they are measured over time. Another
application is the national balance sheet as to assets on one side, including the capital stock, and
liabilities and wealth on the other, measured as of the end of the accounting period. Entries here
are called stocks, to indicate their accumulation to a point in time, as distinct from a flow, which
is measured over time.

National accounts can be presented in nominal from real amounts, that is, correcting money
totals for price changes over time (Sen, 1979; Usher, 1897). Economic growth rates (most
commonly the growth rate of GDP) are generally measured in real (constant price) terms.

The accounts are derived from a wide variety of statistical source data including surveys,
administrative and census data, and regulatory data, which are integrated and harmonised in the
conceptual framework. They are usually compiled by national statistical offices and/or central
banks in each country, though this is not always the case, and may be released on both an annual
and (less detailed) quarterly frequency.

Contents
[hide]

• 1 Development
• 2 Main components
• 3 References

• 4 See also

[edit] Development
The original motivation for the development of national accounts and the systematic
measurement of employment, was the need for accurate measures of aggregate economic
activity. This was made more pressing by the Great Depression and as a basis for Keynesian
macroeconomic stabilisation policy and wartime economic planning. The first efforts to develop
such measures were undertaken in the late 1920s and 1930s, notably by Colin Clark and Simon
Kuznets. Richard Stone led later contributions. The first formal national accounts in the United
States were in 1947 (Ruggles, 1987, p. 377), and national accounts developed in many European
countries during the 1940s and early 1950s.

International rules for national accounting are defined by the United Nations System of National
Accounts, which is currently under update. In Europe the worldwide System of National
Accounts has been transposed into a European System of Accounts (ESA), which is applied by
members of the European Union and many other European countries.

[edit] Main components

The presentation of national accounts data may vary by country (commonly, aggregate measures
are given greatest prominence), however the main national accounts include the following
accounts for the economy as a whole and its main economic actors.

• Current accounts:

production accounts which record the value of domestic output and the goods and
services used up in producing that output. The balancing item of the accounts is value
added, which is equal to GDP when expressed for the whole economy at market prices
and in gross terms;
income accounts, which show primary and secondary income flows - both the income
generated in production (e.g. wages and salaries) and distributive income flows
(predominantly the redistributive effects of government taxes and social benefit
payments). The balancing item of the accounts is disposable income ("National Income"
when measured for the whole economy);
expenditure accounts, which show how disposable income is either consumed or saved.
The balancing item of these accounts is saving.

• Capital accounts, which record the net accumulation, as the result of transactions, of non-
financial assets; and the financing, by way of saving and capital transfers, of the
accumulation. Net lending/borrowing is the balancing item for these accounts
• Financial accounts, which show the net acquisition of financial assets and the net
incurrence of liabilities. The balance on these accounts is the net change in financial
position.
• Balance sheets, which record the stock of assets, both financial and non-financial, and
liabilities at a particular point in time. Net worth is the balance from the balance sheets
(United Nations, 1993).

The accounts may be measured as gross or net of consumption of fixed capital (a concept in
national accounts similar to depreciation in business accounts).
[edit] References
• From (2008) The New Palgrave Dictionary of Economics, 2nd Edition:

"national income" by "Thomas K. Rymes Abstract.

"national accounting, history of" by André Vanoli. Abstract.
"green national accounting" by Sjak Smulders. Abstract.
"intangible capital" by Daniel E. Sichel. Abstract.

• From (1987) The New Palgrave: A Dictionary of Economics:

"social accounting," v. 4, pp. 377–82, Nancy D. Ruggles.

"real income" v. 4, p. 104., by D. Usher.

• T. P. Hill (2001). "Macroeconomic Data," International Encyclopedia of the Social &

Behavioral Sciences, pp. 9111–9117. Abstract.
• Laurence J. Kotlikoff (1992). Generational Accounting. Free Press.
• Amartya Sen (1979). "The Welfare Basis of Real Income Comparisons: A Survey,"
Journal of Economic Literature, 17(1), pp. 1–45.
• United Nations (1993) About the System of National Accounts 1993.

Double-entry bookkeeping system

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This article may require cleanup to meet Wikipedia's quality standards. Please improve
this article if you can. (March 2008)

The double-entry bookkeeping system was started in 13th century and refers to a set of rules to
record financial information in a financial accounting system wherein every transaction or event
impacts at least two different accounts.[1] In modern accounting this is done using debits and
credits, and serves as a kind of error-detection system: if, at any point, the sum of debits does not
equal the corresponding sum of credits, then an error has occurred.

Since there are several different types of errors that can occur which result in equal sums for
debits and credits, double-entry accounting is not a guarantee that no errors exist. However, it is
still useful.
Contents
[hide]

• 1 Timeline
• 2 Significance
• 3 Accounts
• 4 Account Types (Nature)
• 5 Account Types (Periodicity of Flow)
• 6 Accounting Entries
• 7 Books of Accounts
• 8 Bookkeeping process
• 9 Abbreviations used in bookkeeping
• 10 Debits and credits
• 11 Double Entry Example 1
o 11.1 Purchase invoice daybook
o 11.2 Bank payments daybook
o 11.3 Supplier ledger cards
o 11.4 Sales/customers
 11.4.1 Sales daybook
 11.4.2 Customer ledger cards
o 11.5 General (Nominal) ledger
 11.5.1 Bank account
 11.5.2 Unadjusted trial balance
 11.5.3 Profit-and-loss statement and balance sheet
• 12 Double Entry Example 2
o 12.1 Transactions
o 12.2 Ledgers
• 13 See also
• 14 Notes and references

• 15 External links

[edit] Timeline

Century Development Stage

Confucius is described, by Sima Qian and other sources, as having endured a poverty-
551-479
stricken and humiliating youth and been forced, upon reaching manhood, to undertake
BCE
such petty jobs as accounting and caring for livestock. [2]

Roman The origins of a primitive double-entry system may possibly be traced as far back as
 the Roman Empire, in ""ex Oratione Ciceronis pro Roscio Comaedo", and Naturalis
Historiae Plinii, lib. 2, cap. 7 where the advised system was "That the one side of
Empire their book was used for Debitor, the other for Creditor" (Huic Omnia Expensa. Huic
Omnia Feruntur accepta et in tota Ratione mortalium sola. Utramque Paginam facit.).
[citation needed]

Later there are traces of the double-entry system in the accounting of the Islamic
12th
world from at least the 12th century.[1]

The earliest extant records that follow the modern double-entry form are those of
13th
Amatino Manucci, a Florentine merchant at the end of the 13th century.[2]

Some sources suggest that Giovanni di Bicci de' Medici introduced this method for the
14th
Medici bank in the 14th century.

By the end of the 15th century, the merchant venturers of Venice used this system
widely. Luca Pacioli, a monk and collaborator of Leonardo da Vinci, first codified the
15th system in a mathematics textbook of 1494.[3] Pacioli is often called the "father of
accounting" because he was the first to publish a detailed description of the double-
entry system, thus enabling others to study and use it.[4][5]

[edit] Significance
This section requires expansion.

Double-entry bookkeeping has been considered a fundamental innovation and a cornerstone of

Capitalism by such thinkers as Werner Sombart and Max Weber, Sombart writing in "Medieval
and Modern Commercial Enterprise" that:[6]

"The very concept of capital is derived from this way of looking at things; one can say
that capital, as a category, did not exist before double-entry bookkeeping. Capital can be
defined as that amount of wealth which is used in making profits and which enters into
the accounts."

[edit] Accounts
Main article: Account (accountancy)
An accounting system records, retains and reproduces financial information relating to financial
transaction flows and financial position. Financial Transaction Flows primarily encompass
inflows on account of incomes and outflows on account of expenses. Elements of financial
position, including property, money received, or money spent, are assigned to one of the primary
groups i.e. assets, liabilities, and equity.[7]

Within these primary groups each distinctive asset, liability, income and expense is represented
by its respective "account". An account is simply a record of financial inflows and outflows in
relation to the respective asset, liability, income or expense. Income and expense accounts are
considered temporary accounts, since they only represent the inflows and outflows which are
absorbed in the financial position elements on completion of the time period.

[edit] Account Types (Nature)

Type Represent Examples

Tangibles - Plant and Machinery, Furniture

Physically tangible things in the real world
and Fixtures, Computers and Information
Real and certain intangible things not having any
Processing Equipment etc. Intangibles -
physical existence
Goodwill, Patents and Copyrights

Individuals, Partnership Firms, Corporate

entities, Non-Profit Organizations, any
Personal Business and Legal Entities local or statutory bodies including
governments are country, state or local
levels

Temporary Income and Expenditure

Accounts for recognition of the
Nominal implications of the financial transactions Sales, Purchases, Electricity Charges
during each fiscal year till finalisation of
accounts at the end

Example: Sales account is opened for recording the sales of goods or services and at the end of
the financial period the total sales are transferred to the revenue statement account (Profit and
Loss Account or Income and Expenditure Account).

Similarly expenses during the financial period are recorded using the respective Expense
accounts which are also transferred to the revenue statement account. The net positive or
negative balance (profit or loss) of the revenue statement account is transferred to reserves or
capital account as the case may be.

[edit] Account Types (Periodicity of Flow)

The classification of accounts into real, personal and nominal is based on their nature i.e.
physical asset, liability, juristic entity or financial transaction.

The further classification of accounts is based on the periodicity of their inflows or outflows in
context to the fiscal year.

Income is immediate inflow during the fiscal year.

Expense is the immediate outflow during the fiscal year.

Asset is long term inflow with implications extending beyond the financial period and hence
could represent un-claimed income as per traditional view. Conversely, an asset could be valued
at the present value of its future inflows.

Liability is long term outflow with implications extending beyond the financial period and
represents un-amortised expense as per the traditional view. Conversely, a liability could be
valued as the present value of future outflows.

Type of Long Term Long Term Short Term Short Term

Accounts Inflows Outflows Inflows Outflows

Real Accounts Assets

Personal
Assets Liability
Accounts

Nominal
Incomes Expenses
Accounts

Items in accounts are classified into five broad groups, also known as the elements of the
accounts:[8] Asset, Liability, Equity, Revenue, Expense.

The classification of Equity as a distinctive element for classification of accounts is disputable on

account of the "Entity concept" as for the objective analysis of the financial results of any entity
the external liabilities of the entity should not be distinguished from any contribution by the
shareholders.

[edit] Accounting Entries

• The double entry accounting system records financial transactions in relation to asset,
liability, income or expense related to it through accounting entries.
• Any accounting entry in double entry accounting system has two effects one of
increasing one account and decreasing another account by equal amount.
• As any financial transaction has two different effects on two different accounts, it is
known as "double entry" book keeping system.
• If the accounting entries are recorded without any errors, at any point of time the
aggregate balance of all accounts having positive balances will be equal to the aggregate
balance of all accounts having negative balances.
• The double entry bookkeeping system ensures that the financial transaction has equal and
opposite effects in two different accounts.
• The accounting entries use terms such as debit and credit to avoid confusion regarding
the opposite effect of the accounting entry e.g. If an accounting entry debits a particular
account, the opposite account will be credited and vice versa.
• The rules for formulating accounting entries are known as "Golden Rules of
Accounting".
• The accounting entries are recorded in the "Books of Accounts".

[edit] Books of Accounts

It does this by ensuring that each individual financial transaction is recorded in at least two
different nominal ledger accounts within the financial accounting system. The two entries have
equal amounts and opposite signs, so that when all entries in the accounts are summed, the total
is exactly the same, in other words the accounts balance. This is a partial check that each and
every transaction has been correctly recorded. The transaction is recorded as a "debit entry" (Dr.)
in one account, and a "credit" (Cr.) entry in the other account. A debit entry generally means that
value has been added to the account, and a credit entry means that value is being subtracted from
the account. The debit entry will be recorded on the debit side (left hand side) of a nominal
ledger account and the credit entry will be recorded on the credit side (right hand side) of a
nominal ledger account. A nominal ledger has a Debit (left) side and a Credit (right) side. If the
total of the entries on the debit side is greater than the total on the credit side of the nominal
ledger account then that account is said to have a debit balance.

As there are two entries for each transaction, hence the expression Double-Entry is used. As the
total of the debit entries equals the total of the credit entries, when the nominal ledger accounts
are listed in columns, the left column for accounts with net Debit balances and the right column
for accounts with net Credit balances, then the total of all the Debit balances will equal the total
of all the Credit balances. If this does not happen then an error has been made somewhere.
An example of an entry being recorded twice for double-entry bookkeeping would be a supplier's
invoice for stationery costing $100. The expense or Debit entry is Stationery Nominal Ledger a/c
$100 Dr (showing that $100 has been spent on stationery) and the Credit entry is to the Supplier's
Control Nominal Ledger a/c $100 Cr (showing that we now owe the supplier $100). This
transaction has now been recorded twice in the financial accounting system and the total value is
$100 for both Debit and Credit values.

Double entry is only used within the nominal ledgers. It is not used in the daybooks, which
normally do not form part of the nominal ledger system. The information from the daybooks
themselves will be taken and used within the nominal ledger and it is the nominal ledgers that
will ensure the integrity of the resulting financial information created from the daybooks
(provided that the information recorded in the daybooks is correct).

(The reason for this is to limit the number of entries in the nominal ledger: entries in the
daybooks can be totalled before they are entered in the nominal ledger. If there are only a
relatively small number of transactions it may be simpler instead to treat the daybooks as an
integral part of the nominal ledger and thus of the double entry system.)

However as can be seen from the examples of daybooks shown below, it is still necessary to
check, within each daybook, that the postings from the daybook balance.

The double entry system uses nominal ledger accounts. From these nominal ledger accounts a
Trial balance can be created. The trial balance lists all the nominal ledger account balances. The
list is split into two columns, with debit balances placed in the left hand column and credit
balances placed in the right hand column. Another column will contain the name of the nominal
ledger account describing what each value is for. The total of the debit column must equal the
total of the credit column.

From the Trial balance the Profit and Loss Statement and the Balance Sheet can then be
produced. The Profit and Loss statement will contain nominal ledger accounts that are Income or
Expense type nominal ledger accounts. The Balance Sheet will contain nominal ledger accounts
that are Asset or Liability accounts.

[edit] Bookkeeping process

The book keeping process primarily refers to recording the financial effects of financial
transactions only into accounts. The variation between manual and any electronic accounting
system simply stems from the latency [disambiguation needed] between the recording of the financial
transaction and its getting posted in the relevant account. This delay absent in electronic
accounting systems due to instantenous posting into relevant accounts is not replicated in manual
systems thus giving rise to primary books of accounts such as Sales Book, Cash Book, Bank
Book, Purchase Book for recording the immediate effect of the financial transaction.

In the normal course of business, a document is produced each time a transaction occurs. Sales
and purchases usually have invoices or receipts. Deposit slips are produced when lodgements
(deposits) are made to a bank account. Cheques are written to pay money out of the account.
Bookkeeping involves, first of all, recording the details of all of these source documents into
multi-column journals (also known as a books of first entry or daybooks). For example, all
credit sales are recorded in the Sales Journal, all Cash Payments are recorded in the Cash
Payments Journal. Each column in a journal normally corresponds to an account. In the single
entry system, each transaction is recorded only once. Most individuals who balance their cheque-
book each month are using such a system, and most personal finance software follows this
approach.

After a certain period, typically a month, the columns in each journal are each totaled to give a
summary for the period. Using the rules of double entry, these journal summaries are then
transferred to their respective accounts in the ledger, or book of accounts. For example the
entries in the Sales Journal are taken and a debit entry is made in each customer's account
(showing that the customer now owes us money) and a credit entry might be made in the account
for "Sale of Class 2 Widgets" (showing that this activity has generated revenue for us). This
process of transferring summaries or individual transactions to the ledger is called posting. Once
the posting process is complete, accounts kept using the "T" format undergo balancing, which is
simply a process to arrive at the balance of the account.

As a partial check that the posting process was done correctly, a working document called an
unadjusted trial balance is created. In its simplest form, this is a three column list. The first
column contains the names of those accounts in the ledger which have a non-zero balance. If an
account has a debit balance, the balance amount is copied into column two (the debit column). If
an account has a credit balance, the amount is copied into column three (the credit column). The
debit column is then totalled and then the credit column is totalled. The two totals must agree -
this agreement is not by chance - because under the double-entry rules, whenever there is a
posting, the debits of the posting equal the credits of the posting. If the two totals do not agree,
an error has been made either in the journals or during the posting process. The error must be
located and rectified and the totals of debit column and credit column recalculated to check for
agreement before any further processing can take place.

Once the accounts balance, the accountant makes a number of adjustments and changes the
balance amounts of some of the accounts. These adjustments must still obey the double-entry
rule. For example, the "Inventory" account asset account might be changed to bring them into
line with the actual numbers counted during a stock take. At the same time, the expense account
associated with usage of inventory is adjusted by an equal and opposite amount. Other
adjustments such as posting depreciation and prepayments are also done at this time. This results
in a listing called the adjusted trial balance. It is the accounts in this list and their
corresponding debit or credit balances that are used to prepare the financial statements.

Finally financial statements are drawn from the trial balance, which may include:

• the income statement, also known as the statement of financial results, profit and loss
account, or P&L
• the balance sheet, also known as the statement of financial position
• the cash flow statement
 • the statement of retained earnings, also known as the statement of total recognised
gains and losses or statement of changes in equity

[edit] Abbreviations used in bookkeeping

• A/C - Account
• A/R - Accounts Receivable
• A/P - Accounts Payable
• B/S - Balance Sheet
• c/d - Carried down
• b/d - Brought down
• c/f - Carried forward
• b/f - Brought forward
• Dr - Debit
• Cr - Credit
• G/L - General Ledger; (or N/L - Nominal Ledger)
• P&L - Profit & Loss; (or I/S - Income Statement)
• PP&E - Property, Plant and Equipment
• TB - Trial Balance
• VAT - Value Added Tax
• CST - Central Sale Tax
• TDS - Tax Deducted at Source
• MAT - Minimum Alternate Tax
• EBIDTA - Earnings before Interest, Depreciation, Taxes and Amortisation.
• EBDTA - Earnings before Depreciation, Taxes and Amortisation.
• EBT - Earnings before Taxes.
• EAT - Earnings after Tax.
• PAT - Profit after tax
• PBT - Profit before tax
• Dep - Depreciation

[edit] Debits and credits

Main article: Debits and credits

Double-entry bookkeeping is governed by the accounting equation. If revenue equals expenses,

the following (basic) equation must be true:

assets = liabilities + equity

For the accounts to remain in balance, a change in one account must be matched with a change in
another account. These changes are made by debits and credits to the accounts. Note that the
usage of these terms in accounting is not identical to their everyday usage. Whether one uses a
debit or credit to increase or decrease an account depends on the normal balance of the account.
Assets, Expenses, and Drawings accounts (on the left side of the equation) have a normal
balance of debit. Liability, Revenue, and Capital accounts (on the right side of the equation) have
a normal balance of credit. On a general ledger, debits are recorded on the left side and credits on
the right side for each account. Since the accounts must always balance, for each transaction
there will be a debit made to one or several accounts and a credit made to one or several
accounts. The sum of all debits made in any transaction must equal the sum of all credits made.
After a series of transactions, therefore, the sum of all the accounts with a debit balance will
equal the sum of all the accounts with a credit balance.

Debits and credits are then defined as follows:

• debit: A debit is recorded on the left hand side of a T account

• credit: A credit balance is recorded on the right hand side of a 'T' account
• Debit accounts = Asset and Expenses (also debit money received into bank accounts)
• Credit accounts = Gains (income) and Liabilities (also credit money paid out of bank
accounts)

[edit] Double Entry Example 1

In this example the following will be used:

Books of prime entry (Books of original entry)

• Sales Invoice Daybook (records customer Invoice Daybook)

• Bank Receipts Daybook (records customer & non customer receipts)
• Purchase Invoice Daybook (records supplier Invoice Daybook)
• Bank Payments Daybook (records supplier & non supplier payments)

The books of prime entry are where transactions are first recorded. They are not part of the
Double-entry system.

Ledger Cards

• Customer Ledger Cards

• Supplier Ledger Cards
• General Ledger (Nominal Ledger)
• Bank Account Ledger
• Trade Creditors Ledger
• Trade Debtors Ledger

[edit] Purchase invoice daybook

Purchase Invoice Daybook

Date Supplier Name Reference Amount Electricity Widgets

10 July 2006 Electricity Company PI1 1000 1000

12 July 2006 Widget Company PI2 1600 1600

------- ------- -------

Total 2600 1000 1600

==== ==== ====

Credit Debit Debit

Trade Electricity Widgets

Creditors G/L G/L

control a/c a/c a/c

Each individual line is posted as follows:

• The amount value is posted as a credit to the individual supplier's ledger a/c
• The analysis amount is posted as a debit to the relevant general ledger a/c

From example above:

• Line 1 - Amount value 1000 is posted as a credit to the Supplier's ledger a/c ELE01-
Electricity Company
• Line 2 - Amount value 1600 is posted as a credit to the Supplier's ledger a/c WID01-
Widget Company

The totals of each column are posted as follows:

 • Amount total value 2600 posted as a credit to the Trade creditors control a/c
• Electricity total value 1000 posted as a debit to the Electricity General Ledger a/c
• Widget total value 1600 posted as a debit to the Widgets General Ledger a/c

Double-entry has been observed because Dr = 2600 and Cr = 2600.

[edit] Bank payments daybook

The payments book is not part of the double-entry system.

Bank Payments Daybook

Date Supplier Name Reference Amount Suppliers Wages

17 July 2006 Electricity Company BP701 1000 1000

19 July 2006 Widget Company BP702 900 900

28 July 2006 Owner's Wages BP703 400 400

------- ------- -------

Total 2300 1900 400

==== ==== ====

Credit Debit Debit

Bank Trade Wages

Account Creditors control a/c

 control a/c

Keys: PI = Purchase Invoice, BP = Bank Payment

Each individual line is posted as follows:

• The amount value is posted as a debit to the individual supplier's ledger a/c.
• The analysis amount is posted as a credit to the relevant general ledger a/c.

From example above:

• Line 1 - Amount value 1000 is posted as a debit to the Supplier's ledger a/c ELE01-
Electricity Company.
• Line 2 - Amount value 900 is posted as a debit to the Supplier's ledger a/c WID01-Widget
Company.

The totals of each column are posted as follows:

• Amount total value 2300 posted as a credit to the Bank Account.

• Trade Creditors total value 1900 posted as a debit to the Trade creditors control a/c.
• Other total value 400 posted as a debit to the Wages control a/c.

Double-entry has been observed because Dr = 2300 and Cr = 2300.

The daybooks are the key documents (books) to the double entry system. From these daybooks
we create the ledger accounts. Each transaction will be recorded in at least two ledger accounts.

[edit] Supplier ledger cards

Supplier Ledger Cards

A/c Code: ELE01 - Electricity Company

Date Details Reference Amount Date Details Reference Amount

17 July Bank Payments 10 July

BP701 1000 Invoice PI1 1000
2006 Daybook 2006
31 July
Balance c/d 0
2006

------- -------

1000 1000

==== ====

1 August Balance
0
2006 b/d

A/c Code: WID01 - Widget Company

Date Details Reference Amount Date Details Reference Amount

19 July Bank Payments 12 July

BP702 900 Invoice PI2 1600
2006 Daybook 2006

31 July
Balance c/d 700
2006

------- -------

1600 1600

==== ====

1 August Balance
700
2006 b/d
[edit] Sales/customers

[edit] Sales daybook

Sales Invoice Daybook

Date Customer Name Reference Amount Parts Service

2 July 2006 JJ Manufacturing SI1 2500 2500

29 July 2006 JJ Manufacturing SI2 3200 3200

------- ------- -------

Total 5700 2500 3200

==== ==== ====

Debit Credit Credit

Trade Sales Sales

debtors Parts Service

control a/c alabiebi a/c a/c

Each individual line is posted as follows:

• The amount value is posted as a debit to the individual customer's ledger a/c.
• The analysis amount is posted as a credit to the relevant general ledger a/c.

From example above:

 • Line 1 - Amount value 2500 is posted as a debit to the Customer's ledger a/c JJM01-JJ
Manufacturing.
• Line 2 - Amount value 3200 is posted as a debit to the Customer's ledger a/c JJM01-JJ
Manufacturing.

The totals of each column are posted as follows:

• Amount total value 5700 posted as a debit to the Trade debtors control a/c.
• Sales-parts total value 2500 posted as a credit to the Sales parts a/c.
• Sales-service total value 3200 posted as a credit to the Sales service a/c.

Double-entry has been observed because Dr = 5700 and Cr = 5700.

[edit] Customer ledger cards

Customer Ledger cards are not part of the Double-entry system. They are for memorandum
purposes only. They allow you to know the total amount an individual customer owes you.

CUSTOMER LEDGER CARDS

A/c Code: JJM01 - JJ Manufacturing

Date Details Reference Amount Date Details Reference Amount

2 July Sales invoice 20 July Bank receipts

SI1 2500 BR1 2500
2006 daybook 2006 daybook

29 July Sales invoice 31 July

SI2 3200 balance c/d 3200
2006 daybook 2006

------- -------

5700 5700

==== ====
1 August
Balance b/d 3200
2006

[edit] General (Nominal) ledger

GENERAL (NOMINAL) LEDGER

Sales parts

Date Details Reference Amount Date Details Reference Amount

31 July 2 July Sales invoice

Balance c/d 2500 SDB 2500
2006 2006 daybook

------- -------

2500 2500

==== ====

1 August
Balance b/d 2500
2006

Sales service

Date Details Reference Amount Date Details Reference Amount

31 July 29 July Sales invoice

Balance c/d 3200 SDB 3200
2006 2006 daybook
 ------- -------

3200 3200

==== ====

1 August
Balance b/d 3200
2006

Electricity

Date Details Reference Amount Date Details Reference Amount

10 July 31 July
Electricity Co. PDB 1000 Balance c/d 1000
2006 2006

------- -------

1000 1000

==== ====

1 August
Balance b/d 1000
2006

Widgets

Date Details Reference Amount Date Details Reference Amount

12 July 31 July
Widget Co. Pdb 1600 Balance c/d 1600
2006 2006

------- -------

1600 1600

==== ====

1 August
Balance b/d 1600
2006

Other a/c

Date Details Reference Amount Date Details Reference Amount

28 July 31 July
Owner's Wages BPDB 400 Balance c/d 400
2006 2006

------- -------

400 400

==== ====

1 August
Balance b/d 400
2006

Bank Control A/c

Date Details Reference Amount Date Details Reference Amount

31 July Bank receipts 31 July Bank payments
BRDB 2500 BPDB 2300
2006 daybook 2006 daybook

31 July
Balance c/d 200
2006

------- -------

2500 2500

==== ====

1 August
Balance b/d 200
2006

Trade Debtors Control A/c

Date Details Reference Amount Date Details Reference Amount

1 July 31 July Bank receipts

Balance b/d 0 BRDB 2500
2006 2006 daybook

31 July Sales Invoice 31 July

SDB 5700 Balance c/d 3200
2006 Daybook 2006

------- -------

5700 5700
 ==== ====

1 August
Balance b/d 3200
2006

Trade Creditors Control A/c

Date Details Reference Amount Date Details Reference Amount

31 July Bank Payments 1 July

BPDB 1900 Balance b/d 0
2006 Daybook 2006

31 July 31 July Purchase

Balance c/d 700 PDB 2600
2006 2006 Daybook

------- -------

2600 2600

==== ====

1 August
Balance b/d 700
2006

The customers ledger cards shows the breakdown of how the trade debtors control a/c is made
up. The trade debtors control a/c is the total of outstanding debtors and the customer ledger cards
shows the amount due for each individual customer. The total of each individual customer
account added together should equal the total in the trade debtors control a/c.

The supplier ledger cards shows the breakdown of how the trade creditors control a/c is made up.
The trade creditors control a/c is the total of outstanding creditors and the suppliers ledger cards
shows the amount due for each individual supplier. The total of each individual supplier account
added together should equal the total in the trade creditors control a/c.
Each Bank a/c shows all the money in and out through a bank. If you have more than one bank
account for your company you will have to maintain separate bank account ledger in order to
complete bank reconciliation statements and be able to see how much is left in each account.

[edit] Bank account

Bank A/c

Date Details Reference Amount Date Details Reference Amount

1 July 17 July Bank Payments

Balance b/d 0 BP701 1000
2006 2006 Daybook

20 July Bank Receipts 19 July Bank Payments

BR1 2500 BP702 900
2006 Daybook 2006 Daybook

28 July Bank Payments

BP703 400
2006 Daybook

31 July
Balance c/d 200
2006

------- -------

2500 2500

==== ====

1 August
Balance b/d 200
2006

[edit] Unadjusted trial balance

 Trial balance as at 31 July 2006

A/c description Debit Credit

Sales-parts 2500

Sales-service 3200

Widgets 1600

Electricity 1000

Other 400

Bank 200

Trade Debtors Control A/c 3200

Trade Creditors Control A/c 700

------- -------

6400 6400

===== =====

Both sides must have the same overall total

Debits = Credits.
The individual customer accounts are not to be listed in the trial balance, as the Trade debtors
control a/c is the summary of each individual customer a/c......

The individual supplier accounts are not to be listed in the trial balance, as the Trade creditors
control a/c is the summary of each individual supplier a/c.

Important note: this example is designed to show double entry. There are methods of creating a
trial balance that significantly reduce the time it takes to record entries in the general ledger and
trial balance.

[edit] Profit-and-loss statement and balance sheet

Profit and loss statement

for the month ending 31 July 2006

Dr

x Sales

x Sales-parts 2500

x Sales-service 3200

x -------

x 5700

x Widgets 1600

x -------

x Gross Profit 4100

x Less expenses

x Electricity 1000

x Other 400

x -------

x 1400

x -------

x Net Profit 2700

x ====

Balance sheet

as at 31 July 2006

Dr

x Current Assets

x Bank A/c 200

x Trade Debtors 3200

x -------
x 3400

x Current Liabilities

x Trade Creditors 700

x -------

x 700

x -------

x Net Current Assets 2700

x ====

x Capital & Reserves

x Revenue Reserves a/c 2700

x -------

x 2700

x ====

[edit] Double Entry Example 2

[edit] Transactions
XYZ Company is closing its books for the end of the month. Each of the daily journals has been
summarized and the amounts are ready to be transferred to the general ledger. The amounts to be
transferred are:

• Purchase raw materials on trade credit: $500,000

• Pay workers from cash in bank to make goods: $1,500,000
• Pay sales force from cash in bank to sell goods: $1,000,000
• Sell goods for cash: $3,500,000

To close the books for the month, we will adjust expenses and revenue to zero by appropriately
crediting and debiting the income summary and then closing the income summary to retained
earnings (part of equity).

These items are entered in the ledger below; each matching credit and debit have been numbered
to make finding them in the ledger easier.

[edit] Ledgers

General Ledger (in 000s)

Transaction Debit Credit Balance

Expenses

Balance forward -

1 Raw materials $ 500 $ 500

2 Labor $ 1500 $ 2000

3 Sales costs $ 1000 $ 3000

5 Income summary $ 3000 -

Total $ 3000 $ 3000

 Revenue

Balance forward -

4 Revenue from sales $ 3500 $ 3500

6 Income summary $ 3500 -

Total $ 3500 $ 3500

Cash

Balance forward $11000

2 Labor $ 1500 $ 9500

3 Sales costs $ 1000 $ 8500

4 Revenue from sales $ 3500 $12000

Total $ 3500 $ 2500

Accounts Payable

Balance forward $ 1000

1 Raw materials $ 500 $ 1500

Total - $ 500
 Income summary

Balance forward -

5 Expense $ 3000 $ 3000

6 Revenue $ 3500 $ 500

7 Retained earnings $ 500 -

Total $ 3500 $ 3500

Retained earnings

Balance forward $10000

7 Income summary $ 500 $10500

Total - $ 500

Total all accounts: $13500 $13500

The amount in equity (in the form of retained earnings) has changed with a net credit of
$500,000. Since equity has a normal balance of credit, this means there is now $500,000 more in
equity than at the beginning of the month.

[edit] See also

• Nostro and vostro accounts
• Single-entry accounting system

[edit] Notes and references

1. ^ Subhi Y. Labib (1969), "Capitalism in Medieval Islam", The Journal of Economic
History 29 (1): 79–96 [92–3]
2. ^ G. A. Lee (1977), "The Coming of Age of Double Entry: The Giovanni Farolfi Ledger
of 1299-1300", Accounting Historians Journal, 4(2): 79-95
3. ^ Luca Pacioli: The Father of Accounting
4. ^ La Riegola De Libro
5. ^ Livio, Mario (2002). The Golden Ratio. New York: Broadway Books. pp. 130–131.
ISBN 0-7679-0816-3.
6. ^ Lane, Frederic C; Riemersma, Jelle, eds (1953). Enterprise and Secular Change:
Readings in Economic History. R. D. Irwin. p. 38. (quoted in "Accounting and
rationality")
7. ^ Woodford, William; Wilson, Valerie; Freeman, Suellen; Freeman, John (2008).
Accounting: A Practical Approach (2 ed.). Pearson Education. pp. 24. ISBN 978-0-409-
32357-3.
8. ^ IASB Framework for the Preparation and Presentation of Financial Statements,
Paragraph 47