Rich Carreiro <rlcarr[at]animato.arlington.ma.us> writes:

- quote -

Correction -- that would read "and there will be *$700* in
interest expense."

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

"jw" <jw[at]unearthly.net> writes:

First, I'm going to agree with what Tad said. Unless you're
doing this out of curiousity (nothing wrong with that -- I once
double-entry bookkept my life for 3 months, on paper, to teach
myself elementary accounting), take heed of what he said -- the
formal accounting definitions are a bit of overkill for individual
personal finances. Just year-to-year change in net worth is very
likely good enough.

- quote -

Keeping in mind what I said above, you asked for it :-)

[note -- I'm dispensing with using the "debit" and "credit"
terms since they can be confusing to people who haven't cracked
a book on bookkeeping. For example, if you credit an account it's
balance can *decrease* in many common cases].

First, we have to consider the balance sheet accounts relevant
to the transaction. On the asset side we have the IRA account
and on the liability side we have the outstanding balance on
the mortgage.

Then we have the profit and loss accounts. In this case
there's only one -- interest expense.

Say that the house payment is $1,000 of which $300 is principal
and $700 is interest and that before the payment the mortgage
balance is $100,000 and the IRA is $25,000.

Making the $1,000 house payment from your IRA would be
recorded as:
Decrease: IRA account asset by $1,000
Decrease: Mortgage liability by $300
Increase: Interest expense by $700

So at the end of the day the IRA balance will be $24,000,
the mortgage balance will be $99,700 and there will be $300
in interest expense.

- quote -

That's a good approximation. But remember that net worth isn't
assets, it's assets minus liabilities. And that's why (using
the above example) there's only $300 of expense, not $700.
The principal payment does not change net worth. It reduces
assets by $700 but it also reduces liabilities by $700 and so
cancels out. Only the $300 interest payment reduces net worth.

- quote -

No. See above.

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

jw wrote:
- quote -


JW,
I wouldn't focus on the terminology because "income" means one thing for
tax purposes, another for "income & expense statement" purposes, and
probably another as a layman's term.

For a balance sheet you don't enter individual transactions like that. A
balance sheet is simply in itemized list in two categories, the
difference between them is your net worth:

ASSETS
- LIABILITIES (leaves...)

=NET WORTH

I do these for clients and I'll run through the basic scheme, you can do
it in Excel or on a piece of paper. You do up one of these every, say, 3
or 6 months - just add another column - and see how things are ticking
along. Basically this is showing the big-picture effect of your income
(including unrealized gains in investments) and the money you're
spending. Netted out, is your bottom line going up or down, and how
quickly, and why - what went up, what went down? The nice thing is you
aren't sitting there entering every check and figuring out what category
it's in.

First, list assets that you can tap into for cash - the balances in
checking & savings accounts, investment accounts, IRAs, annuities, cash
value insurance, etc. That's one total. (or, you might divide that stuff
into the more accessible ones & the less accessible ones, it's up to you.)

Then list your home, as a separate asset, to make clear that it isn't
like your savings accounts. I think it's good to use a conservative
value, maybe the value from a couple years ago, so you don't end up
having these big fluctuations in your net worth due to your guesstimate
about a short-term run-up. You could even just list it at a fixed value
- that way any change in your bottom line isn't coming from your
estimate of your home value.

I don't typically include a car as an asset unless it's stated at its
true value - say, a low blue-book value...NOT what you paid for it.
Knock it down 10% every 6 months, or keep looking up the value.

Total all that up, that's your "Total Assets" - that's what you own.

Under liabilities list your mortgage, home equity loans or lines of
credit, credit card debts, car loans, all that stuff. On the mortgage,
be sure to list what you actually owe as of the date of the balance
sheet, not the original value of the mortgage. Your lender can provide
that. If you've done anything that triggered taxes, but you haven't paid
them yet, you should list that as a liability too (eg IRA distribution
that you'll pay tax on next April - the tax is a liability, it's
something you owe). Sum all that, your "Total Liabilities" - that's what
you owe.

Then you can figure out your net worth: assets minus liabilities. That's
it. Repeat every so often to get a sense of how the bottom line is doing
and which things are going up & down.

I find that very few people keep a personal balance sheet and it can be
one of the best single tools for figuring out the big picture. Doing
this every so often tells you a lot...whether money is going out the
door, whether your investments/IRAs are keeping up with your spending.
And you do it without needing to track things expense by expense or
worrying about how you categorize a certain check - which I find to be a
pain in the neck.

Back to your Q: look at how it flows out on the balance sheet...when you
take money out of your IRA for a mortgage payment, the IRA value (an
asset) drops, but the mortgage (a liability) drops a little bit too.
Your mortgage payment is part interest, part principal, so you'll see a
drop in net worth from that transaction...the part of your payment
that's interest is going out the window. This is a nice realistic view
of the so-called "tax benefit" of paying a mortgage.

Remember though the limits of this balance sheet - you're just looking
at "what do I have, what do I owe?" This doesn't tell you about income
or expenses, just the netted-out effect of them. But maybe this tells
you what you're looking for, without needing to address things like
whether a payment to a life insurance policy is an expense or a form of
savings or a bit of both.

-Tad

JW wrote in part:
- quote -

news:5wuKe.2708$Z87.1219[at]newssvr14.news.prodigy.com.
Snip
- quote -

Thanks Tad,

Let's assume I am creating a personal Balance Sheet how would I handle the
transaction in Question 2. above. My quess is that it is simply entered as
an Expense - House Payment.

Would I be correct if I considered any thing that increases my "realized net
worth" is income, and anything that decreases my "realized net worth" would
be an expense."

For example, home appreciation would not be classified as income because it
is not realized until the sale of the property.
The entire house payment, both interest and principal, would be considered
an expense because the principal portion is not realized until the sale.

JW

jw wrote:
- quote -

JW,
I'm assuming you're doing this in Quicken or something like that to even
be asking the question. Part of the answer is "why do you care?" The
financial statements you're talking about have very specific purposes
for corporations, and they're prepared in a certain way. If this is for
personal money then the terms are probably more flexible so something
like "cash flow" means "where am I going to get cash and how much can I
get?" rather than "a financial statement prepared in compliance with
GAAP that can be used to reconcile the effects of noncash items like
amortization and depreciation."

In your example of an IRA distribution, you might be thinking of it as
"income" because it generates income taxes. Or you might think of it as
"cash flow" because in retirement an IRA is a source of your cash, a
source of cash flow to pay your bills. So both are correct, when you get
down to it, though a corporation doesn't use the terms that way.

Point being that these are very specific terms in accounting, but you're
using them for your personal finances. I'd say rather than deciphering
the terms focus on the reason you're even looking at these figures. In
general I think the most interesting "financial statements" for an
individual to prepare, and to update periodically, are a Balance Sheet
(what you have, what you owe, what the bottom line net worth is) and a
list of your true expenses, meaning things you spend money on. You can
see a lot from this, more so than looking at your taxable income (which
might vary depending on how much you take out of an IRA, whether you
sell stocks in a given year, whether you sold a house). Changes in your
balance sheet tell you whether you're running down your assets, or
adding to them, and your list of expenses tells you what kind of cash
drain you need to be able to keep up with.

-Tad

"Rich Carreiro" <rlcarr[at]animato.arlington.ma.us> wrote in message
news:m3oe85d4y4.fsf[at]animato.home.lan...

- quote -


I have a really hard time getting my head around this. I'm off to the
library.

JW

"jw" <jw[at]unearthly.net> writes:

- quote -

One shows what happens to cash, the other shows your income and expenses.

Remember -- things that increase cash are not necessarily income and
things that decrease cash are not necessarily expenses. For example,
if you buy stock, your cash flow report will show a decrease in cash
but there is no expense. And if you sell stock, your cash flow report
will show an increase in cash but there is no expense.

- quote -

On an income/expense report, the only thing that would show up from
this transaction would be an entry for Interest Expense in the amount
of the interest portion of that mortgage payment. The rest of the
transaction is a transfer from the IRA Asset to the House Loan
Outstanding Liability. But that transfer is neither income nor an
expense. As for cash flow reports, it shouldn't show up at all, since
none of the involved accounts would be considered cash or cash
equivalents.

- quote -

See above.

- quote -

Go to the library/bookstore and pick up a book on beginning accounting.

But don't feel bad -- confusing income with cash flow is an
all too common thing in the general populace.

--
Rich Carreiro rlcarr[at]animato.arlington.ma.us

I am having a really hard time finding out what exactly goes into these
reports.

Question 1. What is the difference between a Cash Flow report and an Income
/ Expense report.

Question 2. If I write a check from my IRA account to cover my house
payment, how should that transaction show up on a Cash Flow Report, and how
would it show up on an Income / Expense report.

It seems to me it should show up as Income because it is a Distribution from
a retirement account and it should also show up as an Expense because it is
a house payment. How can this be.

I've looked all over the Internet with Google, both the web and groups, and
cannot find the answer. If there is a resource that explains how various
transactions should be handled on these reports could you pass it on to me.

Thanks,

JW