Monday, 12 January 2009

Domestic Accounting in Perspective

In my first, welcome blog, I gave you a very brief overview of some of the ideas behind Domestic Well-Being (DWB) accounting. In this continuing series of Blogs, I would like to delve into more detail about it all in the hope of getting you interested so that you might like to find out more about just how easy it is to gain and exercise control of your personal or home finances.

Before getting into the practicalities, I thought it would be appropriate to set the scene by giving you a few of my thoughts in regard to how accounting fits into the scenario of home or personal domestic life.

Essentially, accounting has evolved over a long time as a set of tools to help manage and control financial activity. Accounting is a way to model financial activity to make its effects more visible so as to be able to understand what is going on behind the scenes as a basis for trying to measure it and where appropriate, change its behaviour in some way.

It is appropriate to realise that financial activity is going on all the time in our daily lives, regardless of whether or not we undertake or do accounting. This happens as we receive money as wages, salary, gifts or whatever; and also as we buy produce or services like food, clothing, utilities, holidays, houses, cars, insurance or stocks and shares. We may also be involved in financial contracts such as for a home mortgage or car purchase loan.

We are actually participants in some form of accounting if we have a bank or credit card account for example. This is because banks and other financial organisations, as with all businesses, are legally required to formally account for all their financial activity. We see evidence of this as we are sent or access on-line, our statements of account for the current or savings accounts that we may have opened with a bank. Remember that these statements are products of the accounting systems run by the banks and therefore give us the bank’s view of the financial activity that they may have been involved in, with us, as their customers. This has some ramifications in respect of terminology, particularly the words debit and credit, but more on that later!

For most people, there are only a few situations in a lifetime where they may become involved with accounting concerning their own financial affairs. The most significant of these and which they will not know anything about, is the winding-up of their affairs after death! Death obviously marks a transition and in civilised society where the state has a great interest in financial matters, mainly because of tax, the transfer of the wealth of the departed to their legal beneficiaries of the estate has to be accomplished in an ordered and formal manner, with legally approved executors to administer these affairs.

Of course, individuals can play an important part in making these procedures as easy as possible for their executors by ensuring that they have drawn up a will and making available as much information as possible for them in appropriate documentation in the records they leave behind. A set of domestic accounts would be perfect!

Interestingly, it is the fact that it is the value of the estate of the deceased that has to be passed on to the beneficiaries of the estate that has an important implication for us if we decide to do proper accounting of our household finances. The implication is that it is the value of the estate which I call the Domestic Wealth that is in effect, owed to the eventual beneficiaries; it is therefore a form of liability of the household to the beneficiaries, without needing to know who they actually might be. We will come back to this point in a later blog when I discuss domestic accounting theory and the so-called, domestic accounting equation.

Other life-time events where accounting may become important is when applying for a home mortgage or other large loan. Usually, quite detailed information about current income, regular outgoings and other liabilities will have to be provided along with credit checks, in order to justify our future ability to be able to afford the repayments on the mortgage or the loan.

When trouble occurs with our finances and debt becomes a serious problem, formal assistance with debt recovery and the various options potentially available such as Individual Voluntary Arrangements (IVA), Debt Management Plans (DMP) or even bankruptcy, may necessitate detailed evaluation of the individual’s financial situation. This could take the form of accounting extracts to build up something similar perhaps to a Statement of Affairs (Debtor’s Petition) which requires very detailed financial information.

Separation or Divorce may also involve aspects of accounting, particularly where ancillary relief proceedings or Financial Dispute Resolution are required in order to resolve any financial issues.

Trusting that most of us will not be too concerned with serious debt or separation, we are mostly not likely to be involved too much with accounting – unless perhaps we act as an executor for someone in regard to the administration of their affairs after death.

Having said that, most of us will dabble on the edges of accounting from time to time at different stages of life, particularly when important decisions have to be made that have cost implications. Most obvious is house purchase and car purchase but even exotic family holidays and Christmas expenses may require some form of financial analysis to determine levels of affordability and budgetary constraints.

Those deciding to tackle financial management a little more seriously may perhaps undertake bank statement reconciliation, some form of budget creation and often these days, utilise spreadsheet programs to try to make more sense of their finances. Income tax obligations require us to gather and bring together financial information once a year to meet our legal commitment to filing proper submissions. This of course is to establish our responsibility regarding how much we have to pay back towards this ever-present demand.

The problem with ad-hoc accounting in order to respond to the need for relatively infrequent financial decision-making is that there will be considerable overheads involved in order to gather, find out and record the necessary information. This may require searching through past records, bank and credit card statements and receipts, assuming that they have been saved and can be found. Then, once it is done, the decision made and the house or whatever purchased, the value of the gathered information will quickly deteriorate over time. Thus when the next decision scenario comes along, the process will effectively have to be repeated all over again, perhaps from scratch.

Furthermore, the information gathered tends to be of the static type, of the value of assets and liabilities. Information about the dynamics of change, the day-to-day increases and decreases, is more difficult to re-establish and will usually again be limited to what can be discovered from individual pay slips, receipts, debit and credit card vouchers and account statements.

At the time of New Year resolutions or other moments of desperation where it is decided to draw up budgets and to start trying to track spending, perhaps using spreadsheets, it is almost impossible without considerable overheads, to categorise and record such spending in a meaningful way. Furthermore, there will usually be no past information (because it hasn’t been collected, collated and saved) against which the new figures can be compared. So often, these initiatives quickly get forgotten and life soon continues on in just the same old way with any financial management being left to instinct and hope, or perhaps plain old intuition.

Credit card balance manipulation may also be very important in the early years when the increases seem way too little to fund the decreases being experienced. Discipline, discipline, discipline!

Yes, the majority of us get by with these methods but what do we really know in detail about our finances? Are we in as good a position as we ought to be? Are we affording the right proportion of our expenditure on the future, compared to the nice-to-have's, now?

The advantages of starting proper domestic accounting are that a routine can quickly be established with very acceptable overheads in terms of cost and time.

With this, information can constantly be collected so that for those major and not so large financial decisions, all the required information is always immediately to hand and past records still available as a base for comparisons.

Furthermore, control of the type attempted by those periodic desperation initiatives can now be undertaken continuously – or even stopped and started as needed – provided the basic bookkeeping is methodically and regularly undertaken.

Even more important, new forms of financial control can be started, addressed by the new concepts embodied in Domestic Well-Being (DWB) Accounting. These are the ideas about achieving the best possible financial balance to ensure that there is an equitable distribution across all the different financial responsibilities facing a household as they constantly change, throughout a lifetime; and also so that debt can be minimised or its recovery managed if it has already occurred.

Next, I want to start telling you about some of the features of DWB accounting – the products, the theory, starting it up and the practicalities of using it on a day-to-day basis.

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