Accounting Primer

Killer Accounting From Outer Space

Science fiction is very cool but you will notice that they do not give the books away. Unfortunately science fiction writers have to eat like everyone else, although if some of them are aliens they may eat unusual things. This brings us, reluctantly, back to THE REAL WORLD. Many people use books as a form of escapism, and I probably have at times also, but escape is limited. At some level we must all cope. So we must all deal with THE LOVE OF MONEY.

Many science fiction stories do not mention money. Watching STAR TREK: THE NEXT GENERATION one would think that money had become obsolete. Other sci-fi universes have rich, powerful villains or corporations engaged in nefarious activities, usually so they can become more rich, more powerful and more nefarious. The good guys inevitably foil their plans of course. But what about YOU? Are you a puppet, a pauper, a pirate, a poet; a pawn, or a king? What do you want to be?

A fifty year old novel regarded as a "classic" is THE SPACE MERCHANTS by Frederick Pohl. It is about an advertising executive trying to get people to emigrate to Venus. It is quite sarcastic about the Ad Biz. Considering its age and looking at television advertising today, it is quite amazing in its apparent prophetic ability. Of course the entire emigration scheme is a plot to get people off the overpopulated planet. The people are to be shot into space to die. With six billion people on the planet and climbing and people sneaking across borders everywhere, the geopolitical-economic dynamics for the next 30 years should be interesting. I am sure more economical methods of getting rid of people will be found.

I had to take four years of English literature in highschool but got zero years of accounting. Two years of math was mandatory though I took four. I guess accounting is more complicated than precalculus. The only thing I was taught about money was how much I would earn on interest on a savings account in Grammar school. Credit cards weren't so common then, therefore computing interest on debts wasn't so important. People did pay mortgages however. I was not taught about amortization schedules. With inexpensive computers having the processing power to run small banks there is no reason why everyone shouldn't have a reasonable grasp of accounting and be ready to take on the economic powerhouses of the planet. The powers that be want all of us to be brainwashed stupid consumers though. I'm sorry but the space merchants aren't shooting me into space. How about you?

The graphic below shows two economic units, a consumer unit and a business unit. In a way 'consumer unit' is a misnomer because a consumer is just as much a business as anyone else. Consumers aren't supposed to think like businessmen though. Businessmen want consumers to be dumb, but they won't say so in public. The consumer has income, probably from a job which is also a business transaction. The consumer makes purchasing decisions which result in expenses, also business transactions. The loss of wealth which is unavoidable due to wear and tear on most posessions is called depreciation. The economics profession appears to be inconsistent in dealing with this depreciation. For the most part the economists totally ignore depreciation, but when pushed they will mention the depreciation of the business unit. They NEVER say anything about the depreciation of the consumer unit. So in accounting terms this blindness to consumer depreciation is the only difference between consumer accounting and business accounting. Consumers cannot file their depreciation with the IRS, therefore the federal government makes higher laws than the laws of physics. No doubt the celestial powers are amused.

"To Win the Game You Must Be Able to Keep The Score!"

The above quotation is on the back of the book FINANCE & ACCOUNTING by Suzanne Caplan. On the front it says, "How to Keep Your Books and Manage Your Finances without an MBA, a CPA, or a Ph.D." Considering the alphabet soup one would think this book symplifies the extremely complicated, but the book RICH DAD, POOR DAD by Robert Kiyosaki says that accounting is fifth grade arithmatic and he is a millionaire. Strange things start happening when money gets involved.

Sophisticated banking goes back to 13th century Florence. So accounting must be at least 700 years old. How complicated can it be? Are we supposed to believe that people who can program computers, fly jet planes, or rebuild car engines can't understand accounting? Is it more likely that MBAs and CPAs are taking us for a ride? We are being confused by the wordnoise of debits and credits instead of enlightened. Caplan's book looks good as accounting books go, but it contains no graphics showing flow of money even though part one says, "Keeping Track of Inflow and Outflow." Chapter One is: What Is a General Ledger?, she doesn't mention Net Worth until page 35 though the index says page 56. Maybe accountants think that businesses exist to create jobs for accountants.

Most accounting books are intended for businesses rather than worker/consumers and are more complex than consumers need. They usually have a bottom up approach which tends to get one lost in the details. I'm going to go top down while emphasizing the concerns of the average man. Page 35 of Caplan's book says NET WORTH is "a number you must know and understand." I can't argue with that, but considering that it appears on one page of a 330 page book and NET WORTH IS NOT LISTED IN THE GLOSSARY I doubt that a neophyte would quickly realize that NET WORTH IS HOW YOU KEEP SCORE.

The basic accounting equation is: NET WORTH = ASSETS - LIABILITIES. This equation applies to both economic units in the graphic. Both economic units have a vested interest in increasing their NET WORTH. The consumer unit spending money is decreasing its Net Worth, while that of the business unit is increasing. The consumer has to make the decision regarding the cost versus the benefit of the expenditure. Of course the business is going to try to encourage the expenditure. Economists talk about standard of living and usually associate this with income and say little to nothing about Net Worth. Net Worth can be more important than income, and standard of living is too vague to be meaningful. Quality of life can matter to an individual but accountants and economists cannot measure it. Only the individual can judge, so it belongs in the realm of psychology not economics. The state of one's finances can easily have adverse effects on quality of life though, bill collectors calling must be annoying and that brings up the subject of liabilities.

Some businesses are in the business of selling money. Of course they expect to be paid more than they sell. Though this looks somewhat like getting something for nothing it is really all in the timing. If a consumer NEEDS SOMETHING IMMEDIATELY but cannot pay cash, such a business can LEND THE MONEY and be paid back MORE MONEY, OVER TIME. This of course means the consumer is taking on a liability. LIABILITIES ARE BAD FOR NET WORTH. What is worth taking on a liability for? Suppose a consumer gets a good paying job, but requires a car to get there in a reasonable amount of time. So the consumer borrows money to get a decent used car. The job provides the income to pay the expense of the liability. Hopefully it is even more than worth the expense. Another factor to consider is the DEPRECIATION OF THE CAR. Machines wear out. The value of the car will decrease with time and use, this will affect Net Worth in addition to the expense of the liability. The banks and other lending companies have the experience and computer programs to account for all of this, it is usually the consumer who is at a disadvantage.

Credit cards are an easier and more tempting method of taking on liabilities. While a car loan or mortgage will have a fixed monthly payment the credit card bill will get smaller as the balance declines. This stretches out payments and interest ad nauseum. If you use credit cards, never make minimum payments. When you pay the cards at an accelerated rate the banks may send you bills of zero balance. Never forget, LENDING BUSINESSES WANT YOU IN DEBT, but being in debt is bad for your Net Worth. Liabilities put you in economic servitude to other people, which keeps you on your job. You don't want a JOB. You want NET WORTH.

Credit cards make shopping convenient and many people pay off the balance every month so the liability aspect is not a problem. There is still the question of what to purchase. American consumer society has no shortage of things to buy. This is in part a quality of life issue and each individual's joys and tastes enter into it, but long term economic consequences affect future quality of life, so thinking ahead can help. What you spend money on today can affect your economic options in the future. A friend of mine hinted that I should spend $1000 on a suit, I didn't even think about it. I invited her to an estate auction that was offering Oriental rugs, she was not interested. I consider suits to be esthetically boring but Oriental rugs are beautiful, Chinese designs, not Persian. Everything you own is only WORTH WHAT YOU CAN SELL IT FOR, NOT WHAT YOU PAYED FOR IT! Therefore if I spend $1000 on a suit, it is only worth what I can sell it for, the same applies to the Oriental rug. The suit will be tailored to fit me so the market for the suit will be quite limited and difficult to find, most people don't buy used clothes anyway. It is doubtful that I could get $100 for a used $1000 suit. Therefore I should expect to loose at least $900 in depreciation on the suit BEFORE I buy it. Why would I throw away $900? If I spent $1000 on a rug at an auction the situation is entirely different. The rug is not customized and they don't change style so the depreciation should be minimal. The rug will be sold to the highest bidder at the auction. How much is it worth? How well do I know rugs? How much will other people bid? Theoretically I could get a $2000 rug for $1000, so I could sell the rug for more than I payed for it. I would benefit from appreciation instead of losing to depreciation.

Since winning means maximizing Net Worth, then losses due to depreciation should be anticipated in advance. Money spent on clothing is nearly a total loss in relation to Net Worth, a possible exception being mink coats which would have a resale value. The constant change in fashion keeps people from using clothing until it shows some wear, except jeans which are sold with preexisting wear. If a woman buys a dress for $100 with a credit card and then makes minimum payments and wears the dress 10 times before it is out of style, the dress could cost $20 per use and then hang in a closet for years. Depending on the interest rate the dress could cost twice what it sold for. A major department store offers a credit card at 20% interest and I have read it makes almost as much money on interest as it does on its products. A lot of people are sabotaging their Net Worth.

Technology has been changing more quickly in the last 200 years than it had in the previous 2000. 200 years ago people were using horses for transportation and the first steam locomotives weren't yet running. Consumers today purchase products much more complex than steam engines but the people promoting technology don't necessarily have the consumers best interest at heart. The perfect example of this is Thomas Edison. Did you know that Edison invented and advocated the use of the electric chair as a means of execution? Edison wanted to sell DC generators and the electric chair uses AC. By getting the public to associate AC current with death Edison hoped to sabotage the implementation of AC power distribution. AC power distribution is far more efficient and economical due to its ability to produce high voltages, which can kill, but DC power distribution makes no engineering sense because it can't be transmitted long distances. So people promoting technology may not be doing it in a way to best serve you, but to best serve them. This can increase your expenses and your depreciation so you need to be technologically astute in the information age.

A major source of both liabilities and depreciation is the automobile. According to one website cars last an average of 12 years and 128,000 miles. It did not say anything about expensive cars lasting longer than cheap cars. In the first year a new car looses 25% to 45% in depreciation, 10% the second year, and it is a straight line to zero for the next ten years. In 1975 Sylvia Porter's MONEY BOOK said a new car looses 50% depreciation in the first two years, and the automobile industry has been encouraging people to trade in their cars every three years since Genesis. It would be interesting to know how much American consumers have lost on depreciation of automobiles since WWII. I bet 'a lot' would be a phenomenal understatement.

So what do you do if you need a car? Avoiding that big drop in depreciation in the first three years is almost the only logical thing to do. According to the book, THE MILLIONAIRE NEXT DOOR, 36% of millionaires buy used cars. So suppose we have two consumers who do not own cars but have both saved $12,000 and need to buy automobiles. Assume they both have the same income and credit rating. One consumer likes a car that costs $30,000, so he pays $10,000 cash and borrows $20,000 to buy the car. The other consumer looks around for a decent used car with less than 40,000 miles and pays $8,500. He then takes the car to a mechanic to be checked out and spends $1,500 for tires, battery, and minor repairs. Since the new car hasn't been paid for the bank wants its property protected. The new car MUST have collision insurance. The owner of the used car has the option of not buying it. Who cares about a dent in a used car? That could save $500 per year. If the new car looses 30% in value the first year, that is $9,000, almost 50% of the amount borrowed, almost enough to pay for the used car. Even if someone can "afford" to buy a new car every three years, many more lasting things could be purchased instead. Lots of Oriental rugs. There are rugs more than 100 years old that sell for thousands of dollars. There are cars like that too but they don't make them that way anymore.

The major and usually unavoidable expense is housing. You MUST keep the rain off the Oriental rugs! I will discuss three options. Rent, buy a house, buy a building and be a landlord. Rent is an ongoing expense. If you pay $1000 per month in rent for 30 years, that's $360,000, and what do you have to show for it in Net Worth? NOTHING!!! You might save the rent reciepts, but who would bother? The alternative is to buy and build up equity. It takes 22 years to get 50% equity on a 30 year mortgage. If you pay an extra amount each month, the additional payment goes straight to principal, alias equity, alias Net Worth. There are computer programs which will calculate savings in time and interest. One is called ACCELER8.EXE. It is a DOS program. The last option, which I took, is buy a 4-unit building and live in one apartment. Of course the problem is dealing with tenants and the advantage is the tenants pay the mortgage. Their rent builds my equity and I have to live with the stigma of being a capitalist swine. C'EST LA VIE!

NOW! What does all that have to do with the General Ledger that Suzanne Caplan began her accounting book with. All of these inflows and outflows of cash and expenses and liabilities must be tracked to keep the score, i.e. Net Worth. My income accounts would be salary and rents. I can choose to have 3 seperate rent accounts, one for each apartment. Expense accounts would be gas, electricity, water, mortgage. I would have two gas and electricity accounts, personal and building. I could have totally seperate databases for personal and building. Personal stuff could be food, electronics, furnishings. It might make sense to have seperate accounts for Oriental rugs and all other furnishings. Most furnishings depreciate and don't have much resale value. I could divide electronics into computers, stereo and video. I want to emphasize computers because of depreciation. Advancing technology is causing computer tech to depreciate rapidly. A $3000 laptop may only be worth $1500 in a year. It is possible to get a refubished IBM Thinkpad for $500 from TigerDirect.com. Load Linux on it and you have a hot computer. Unless that $3,000 laptop can do something really important why blow that cash? The new laptop will probably have a DVD recorder and the used laptop may just have a CD-ROM drive. The hard disk will be bigger on the new machine and it will have a faster clock of at least 1.5 GHz. The used computer may be only 300 MHz and have a 5 gig hard disk but this is approximately equivalent to an IBM 3033 mainframe circa 1980. Enough power to run a small bank. How many people really need to carry around more power than that?

So, that about covers mini-accounting. I just wanted to reveal a perspective that is difficult to get from accounting books. Bean counting can cause myopia. The distribution of wealth in the U.S. has been getting more unequal for the last 30 years. Too many people have been playing the game badly, but only because they aren't told what is really happening. I think accounting and economics should be mandatory in highschool. So good luck and buy nice Oriental rugs. LOL!

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