Before you begin working on GnuCash, It is recommended you have a basic understanding of Accounting Concepts, and that you understand this section before proceeding.
GnuCash is easy enough to use that you do not need to have a complete understanding of accounting principles to find it useful. However, you will find that some basic accounting knowledge will prove to be invaluable as GnuCash was designed using these principles as a template.
The 5 Basic Accounts
Basic accounting rules group all finance-related things into 5 fundamental types of “accounts”. That is, everything that accounting deals with can be placed into one of these 5 accounts:
Assets -Things you own
Liabilities -Things you owe
Equity- Overall net worth
Income – Increases the value of your accounts
Expenses – Decreases the value of your accounts
It is clear that it is possible to categorize your financial world into these 5 groups.
For example, the cash in your bank account is an asset, the business loan you owe the bank is a liability, money earned in the course of your business is income, and the cost of office supplies for your business is an expense.
The Accounting Equation
The relationship between 5 basic accounts and how one type of account affect the others:
Assets – Liabilities = Equity
You can increase your equity through income, and decrease equity through expenses. For Example: when you receive sales income you become “richer” and when you pay for office expenses you become “poorer”. This is expressed mathematically in what is known as the
Assets – Liabilities = Equity + (Income – Expenses)
This equation must always be balanced, a condition that can only be satisfied if you enter values to multiple accounts.
For example: if you receive money in the form of income you must see an equal increase in your assets.
As another example, you could have an increase in assets if you have a parallel increase in liabilities. Such as in the case of a business loan that increases your assets.
The Double Entry System of Accounting
GnuCash uses what’s called a double-entry accounting system. This is a formal system that’s a worldwide standard for accounting.
What a double-entry system means is that every single transaction or every record in GnuCash has at least two records that are going on behind the scenes. There are two transactions, a debit, and credit, and they have to add up to the same amount.
Most of the time, you don’t see this happening. For example, when I create an invoice, you’re sending it out to a customer, and an account of yours will get debited. That account is the accounts receivable account. It’s the account that’s waiting for this money.
When your customer pays you, that payment gets credited from your accounts receivable, and it’s being debited into your company’s checking account, which is where the money is arriving.
Every single transaction needs this double system to tell it where to go and where it’s coming from. In fact, different types of accounts will handle debts and credits differently. In some accounts, a credit means the account is decreasing in value, and in others, it means the account is increasing.
GnuCash makes it easy for newbies to enter debits and credit transactions by using the term deposits and withdrawals instead of debits and credits. If you prefer to use the term debits and credits it is possible to turn on that feature.