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<chapter id="chapter_capgain">
  <title>Capital Gains</title>

  <para>This chapter will present some of the techniques used to keep track of
  the unrealized and realized gains and losses, better known as capital gains
  and losses.</para>

  <sect1 id="capgain_concepts1">
    <title>Basic Concepts</title>

    <para>This chapter will present some of the techniques used to keep track
    of the unrealized and realized gains and losses, better known as capital
    gains and losses.</para>

    <para>Certain resellable assets can change value over time, such as
    stocks, bonds, houses, or cars. Some assets (eg: a stock) could increase
    in value, some (eg: a car) could decrease in value. It is important to be
    able to track some of these time-dependent asset valuations, this chapter
    will show you how.</para>

    <para>Probably everything you own will increase or decrease in value over
    time. So, the question is for which of these assets should you track this
    changing value? The simple answer is that you only need to track this for
    items which could be sold for cash in the future or which relate to
    taxation.</para>

    <para>Consumable and disposable items (eg: food, gas for your car, or
    printer paper) are obviously not involved. Thus, even though the new
    clothes you recently bought will certainly depreciate, you would not want
    to track this depreciation since you have no intention of reselling the
    clothes and there is no tax implications to the depreciation on clothing.
    So, for this example, the purchase of new clothes should be recorded as a
    pure expense... you spent the money, and it is gone.</para>

    <para>Asset appreciation occurs when something you own increases in value
    over time. When you own an asset which has increased in value, the
    difference between the original purchase price and the new value is known
    as <emphasis>unrealized gains</emphasis>. When you sell the asset, the
    profit you earn is known as <emphasis>realized gains</emphasis> or
    <emphasis>capital gains</emphasis>. An example of an asset from which you
    could have unrealized gains, and eventually capital gains, is stock in a
    publicly traded company.</para>
  </sect1>

  <sect1 id="capgain_value1">
    <title>Estimating Valuation</title>

    <para>As mentioned in the introduction to this chapter, capital gains are
    the profits received from the sale of an asset. This section will describe
    how to record capital gains in <application>&app;</application>.</para>

    <para>The accounting methods for handling asset appreciation differs
    somewhat from depreciation because typically you are only concerned with
    the moment you sell the asset and realize the capital gains. This is
    opposed to the continuous nature of tracking depreciation. Capital gains
    are an important subject in the world of taxation, because governments
    tend to be quite interested in taxing capital gains in one manner or
    another.</para>

    <note>
      <para>As always, there are exceptions. If you hold a bond that pays all
      of its interest at maturity, tax authorities often require that you
      recognize interest each year, and refuse this to be treated as a capital
      gain. Consult the appropriate tax codes to determine the preferred
      treatment for each type of asset you have which may be affected by
      capital gains taxes.</para>
    </note>

    <para>Estimating the increasing value of assets is generally not simple,
    because often it is difficult to know its exact value until the moment it
    is sold.</para>

    <para>Securities traded daily on open markets such as stock exchanges are
    possibly the easiest type of asset to predict the value of, and selling
    the asset at market prices may be as simple as calling a broker and
    issuing a Market Order. On the other hand, estimating the value of a house
    is more difficult. Homes are sold less often than stocks, and the sales
    tend to involve expending considerable effort and negotiations, which
    means that estimates are likely to be less precise. Similarly, selling a
    used automobile involves a negotiation process that makes pricing a bit
    less predictable.</para>

    <para>Values of collectible objects such as jewelry, works of art,
    baseball cards, and <quote>Beanie Babies</quote> are even harder to estimate. The
    markets for such objects are much less open than the securities markets
    and less open than the housing market. Worse still are one-of-a-kind
    assets. Factories often contain presses and dies customized to build a
    very specific product that cost tens or hundreds of thousands of dollars;
    this equipment may be worthless outside of that very specific context. In
    such cases, several conflicting values might be attached to the asset,
    none of them unambiguously correct.</para>

    <para>The general rule of thumb in accounting for estimating unrealized
    gains (or loses) is that you should only revalue assets such as stocks
    which are readily sellable and for which there are very good estimates of
    the value. For all other assets, it is better to simply wait until you
    sell them, at which time you can exactly determine the capital gains. Of
    course, there is no hard rule on this, and in fact different accountants
    may prefer to do this differently.</para>
  </sect1>

  <sect1 id="capgain_accounts1">
    <title>Account Setup</title>

    <para>As with most accounting practices, there are a number of different
    ways to setup capital gains accounts. We will present here a general
    method which should be flexible enough to handle most situations. The
    first account you will need is an <emphasis>Asset Cost</emphasis> account
    (<application>&app;</application> account type <guilabel>Asset</guilabel>), which is simply a place where you record
    the original purchase of the asset. Usually this purchase is accomplished
    by a transaction from your bank account.</para>

    <para>In order to keep track of the appreciation of the asset, you will
    need three accounts. The first is an <emphasis>Unrealized Gains</emphasis>
    asset account in which to collect the sum of all of the appreciation
    amounts. The <emphasis>Unrealized Gains</emphasis> asset account is balanced by a
    <emphasis>Unrealized Gains</emphasis> income account, in which all
    periodic appreciation income is recorded. Finally, another income account
    is necessary, called a <emphasis>Realized Gains</emphasis> in which you
    record the actual capital gains upon selling the asset.</para>

    <para>Below is a generic account hierarchy for tracking the appreciation
    of 2 assets, <emphasis>ITEM1</emphasis> and <emphasis>ITEM2</emphasis>. The <emphasis>Assets:Fixed Assets:ITEM1:Cost</emphasis> accounts are
    balanced by the <emphasis>Assets:Current Assets:Savings Account</emphasis> account, 
    the <emphasis>Assets:Fixed Assets:ITEM1:Unrealized Gains</emphasis>
    accounts are balanced by the <emphasis>Income:Unrealized Gains</emphasis> account (similar for <emphasis>ITEM2</emphasis>).</para>

    <literallayout>
-Assets
    -Current Assets
        -Savings Account
    -Fixed Assets
        -ITEM1 
            -Cost
            -Unrealized Gain
        -ITEM2
            -Cost
            -Unrealized Gain
-Income
    -Realized Gains
    -Unrealized Gains
  </literallayout>
  </sect1>

  <sect1 id="capgain_example1">
    <title>Example</title>

    <para>Let&rsquo;s suppose you buy an asset expected to increase in value, say a
    Degas painting, and want to track this. (The insurance company will care
    about this, even if nobody else does.)</para>

    <para>Start with an account hierarchy similar to than shown in <xref
    linkend="capgain_accounts1" />, but replace <quote>ITEM1</quote> with <quote>Degas</quote> and you
    can remove the <quote>ITEM2</quote> accounts. We will assume that the Degas painting
    had an initial value of one hundred thousand dollars. Begin by giving your
    self $100,000 in the bank and then transferring that from your bank
    account to your <emphasis>Assets:Fixed Assets:Degas:Cost</emphasis> account (the asset
    purchase transaction). You should now have a main account window which
    appears like this:</para>

    <screenshot id="capgain_appmain">
      <mediaobject>
        <imageobject>
          <imagedata fileref="figures/capgain_appmain.png" format="PNG"
                     srccredit="Bengt Thuree" />
        </imageobject>

        <textobject>
          <phrase>Asset Appreciation Main Window</phrase>
        </textobject>

        <caption><para>The asset appreciation example main window
        </para></caption>
      </mediaobject>
    </screenshot>

    <sect2 id="capgain_exampleunrealized2">
      <title>Unrealized Gains</title>

      <para>A month later, you have reason to suspect that the value of your
      painting has increased by $10,000 (an unrealized gain). In order to
      record this you transfer $10,000 from your <emphasis>Accrued Gains</emphasis> income account
      (<emphasis>Income:Unrealized Gains</emphasis>) to your asset Unrealized Gains account
      (<emphasis>Assets:Fixed Assets:Degas:Unrealized Gain</emphasis>). Your main window will
      resemble this:</para>

      <screenshot id="capgain_app2main">
        <mediaobject>
          <imageobject>
            <imagedata fileref="figures/capgain_app2main.png" format="PNG"
                       srccredit="Bengt Thuree" />
          </imageobject>

          <textobject>
            <phrase>Asset Appreciation Main Window</phrase>
          </textobject>

          <caption><para>Chart of Accounts after unrealized
          gain</para></caption>
        </mediaobject>
      </screenshot>
    </sect2>

    <sect2 id="capgain_examplesell2">
      <title>Selling</title>

      <para>Let&rsquo;s suppose another month later prices for Degas paintings have
      gone up some more, in this case about $20,000, you estimate. You duly
      record the $20,000 as an unrealized income like above, then decide to
      sell the painting.</para>

      <para>Three possibilities arise. You may have <emphasis>accurately
      estimated</emphasis> the unrealized gain,
      <emphasis>underestimated</emphasis> the unrealized gain, or
      <emphasis>overestimated</emphasis> the unrealized gain.</para>

      <orderedlist>
        <listitem>
          <para><emphasis>Accurate estimation</emphasis> of unrealized
          gain.</para>

          <para>Your optimistic estimate of the painting&rsquo;s value was correct.
          First you must record that the profits made are now realized gains,
          not unrealized gains. Do this by transferring the income from the
          <emphasis>Income:Unrealized Gains</emphasis> to the 
          <emphasis>Income:Realized Gains</emphasis> account.</para>

          <para>Secondly, you must credit your bank account with the selling
          price of the painting. This money comes directly from your
          <emphasis>Assets:Fixed Assets:Degas</emphasis> sub-accounts. Transfer the full
          <emphasis>Assets:Fixed Assets:Degas:Cost</emphasis> value into 
          <emphasis>Assets:Current Assets:Savings Account</emphasis>, and the full 
          <emphasis>Assets:Fixed Assets:Degas:Unrealized Gain</emphasis> into 
          <emphasis>Assets:Current Assets:Savings Account</emphasis>.</para>

          <para>These transactions should now appear as follows:</para>

          <para><table>
              <title>Turning an Accrued Gain into a Realized Gain</title>

              <tgroup cols="4">
                <tbody>
                  <row>
                    <entry><emphasis>Account</emphasis></entry>

                    <entry><emphasis>Transfer to</emphasis></entry>

                    <entry><emphasis>Transaction Amount</emphasis></entry>

                    <entry><emphasis>Account Total</emphasis></entry>
                  </row>

                  <row>
                    <entry>Income:Unrealized Gains</entry>

                    <entry>Income:Realized Gains</entry>

                    <entry>$30,000</entry>

                    <entry>$0</entry>
                  </row>

                  <row>
                    <entry>Assets:Fixed Assets:Degas:Cost</entry>

                    <entry>Assets:Current Assets:Savings Account</entry>

                    <entry>$100,000</entry>

                    <entry>$0</entry>
                  </row>

                  <row>
                    <entry>Assets:Fixed Assets:Degas:Unrealized Gains</entry>

                    <entry>Assets:Current Assets:Savings Account</entry>

                    <entry>$30,000</entry>

                    <entry>$0</entry>
                  </row>
                </tbody>
              </tgroup>
            </table></para>

          <para>This leaves the <emphasis>Assets:Current Assets:Savings Account</emphasis> account
          with a total of $130000 and <emphasis>Income:Realized Gains</emphasis> with a total of
          $30000.</para>

          <screenshot id="capgain_app3main">
            <mediaobject>
              <imageobject>
                <imagedata fileref="figures/capgain_app3main.png" format="PNG"
                           srccredit="Bengt Thuree" />
              </imageobject>

              <textobject>
                <phrase>Asset Appreciation Main Window</phrase>
              </textobject>

              <caption><para>Chart of Accounts after realized
              gain</para></caption>
            </mediaobject>
          </screenshot>
        </listitem>

        <listitem>
          <para><emphasis>Under estimation</emphasis> of unrealized
          gain.</para>

          <para>You were over-optimistic about the value of the painting.
          Instead of the $130000 you thought the painting was worth are only
          offered $120000. But you still decide to sell, because you value
          $120000 more than you value the painting. The numbers change a
          little bit, but not too dramatically.</para>

          <para>The transactions should now appear as follows (observe the
          last transaction which balances the <emphasis>Unrealized Gains</emphasis>
          accounts):</para>

          <para><table>
              <title>Turning an Accrued Gain into a Realized Gain</title>

              <tgroup cols="4">
                <tbody>
                  <row>
                    <entry><emphasis>Account</emphasis></entry>

                    <entry><emphasis>Transfer to</emphasis></entry>

                    <entry><emphasis>Transaction Amount</emphasis></entry>

                    <entry><emphasis>Account Total</emphasis></entry>
                  </row>

                  <row>
                    <entry>Income:Unrealized Gains</entry>

                    <entry>Income:Realized Gains</entry>

                    <entry>$20,000</entry>

                    <entry>$10,000</entry>
                  </row>

                  <row>
                    <entry>Assets:Fixed Assets:Degas:Cost</entry>

                    <entry>Assets:Current Assets:Savings Account</entry>

                    <entry>$100,000</entry>

                    <entry>$0</entry>
                  </row>

                  <row>
                    <entry>Assets:Fixed Assets:Degas:Unrealized Gains</entry>

                    <entry>Assets:Current Assets:Savings Account</entry>

                    <entry>$20,000</entry>

                    <entry>$10,000</entry>
                  </row>

                  <row>
                    <entry>Assets:Fixed Assets:Degas:Unrealized Gains</entry>

                    <entry>Income:Unrealized Gains</entry>

                    <entry>$10,000</entry>

                    <entry>$0</entry>
                  </row>
                </tbody>
              </tgroup>
            </table></para>

          <para>This leaves the <emphasis>Assets:Current Assets:Savings Account</emphasis> account
          with a total of $120000 and <emphasis>Income:Realized Gains</emphasis> with a total of
          $20000.</para>
        </listitem>

        <listitem>
          <para><emphasis>Over estimation</emphasis> of unrealized
          gain.</para>

          <para>You manage to sell your painting for more than you thought in
          your wildest dreams ($150,000). The extra value is, again, recorded
          as a gain, i.e. an income.</para>

          <para>The transactions should now appear as follows (observe the
          last transaction which balances the Unrealized Gains
          accounts):</para>

          <para><table>
              <title>Turning an Accrued Gain into a Realized Gain</title>

              <tgroup cols="4">
                <tbody>
                  <row>
                    <entry><emphasis>Account</emphasis></entry>

                    <entry><emphasis>Transfer to</emphasis></entry>

                    <entry><emphasis>Transaction Amount</emphasis></entry>

                    <entry><emphasis>Account Total</emphasis></entry>
                  </row>

                  <row>
                    <entry>Income:Unrealized Gains</entry>

                    <entry>Income:Realized Gains</entry>

                    <entry>$50,000</entry>

                    <entry>$-20,000</entry>
                  </row>

                  <row>
                    <entry>Assets:Fixed Assets:Degas:Cost</entry>

                    <entry>Assets:Current Assets:Savings Account</entry>

                    <entry>$100,000</entry>

                    <entry>$0</entry>
                  </row>

                  <row>
                    <entry>Assets:Fixed Assets:Degas:Unrealized Gains</entry>

                    <entry>Assets:Current Assets:Savings Account</entry>

                    <entry>$50,000</entry>

                    <entry>$-20,000</entry>
                  </row>

                  <row>
                    <entry>Income:Unrealized Gains</entry>

                    <entry>Assets:Fixed Assets:Degas:Unrealized Gains</entry>

                    <entry>$20,000</entry>

                    <entry>$0</entry>
                  </row>
                </tbody>
              </tgroup>
            </table></para>

          <para>This leaves the <emphasis>Assets:Current Assets:Savings Account</emphasis> account
          with a total of $150,000 and <emphasis>Income:Realized Gains</emphasis> with a total of
          $50,000.</para>
        </listitem>
      </orderedlist>
    </sect2>

    <sect2 id="capgain_examplecaution2">
      <title>Caution about Valuation</title>

      <para>As we see in this example, for non-financial assets, it may be
      difficult to correctly estimate the <quote>true</quote> value of an asset. It is
      quite easy to count yourself rich based on questionable estimates that
      do not reflect <quote>money in the bank</quote>.</para>

      <para>When dealing with appreciation of assets,</para>

      <itemizedlist>
        <listitem>
          <para>Be careful with your estimation of values. Do not indulge in
          wishful thinking.</para>
        </listitem>

        <listitem>
          <para>Never, ever, count on money you do not have in your bank or as
          cash. Until you have actually sold your asset and got the money, any
          numbers on paper (or magnetic patterns on your hard disk) are merely
          that. If you could realistically convince a banker to lend you
          money, using the assets as collateral, that is a pretty reasonable
          evidence that the assets have value, as lenders are professionally
          suspicious of dubious overestimations of value. Be aware: all too
          many companies that appear <quote>profitable</quote> on paper go out of business
          as a result of running out of cash, precisely because <quote>valuable
          assets</quote> were not the same thing as cash.</para>
        </listitem>
      </itemizedlist>
    </sect2>
  </sect1>

  <sect1 id="capgain_tax1">
    <title>Taxation</title>

    <para>Taxation policies vary considerably between countries, so it is
    virtually impossible to say anything that will be universally useful.
    However, it is common for income generated by capital gains to not be
    subject to taxation until the date that the asset is actually sold, and
    sometimes not even then. North American home owners usually find that when
    they sell personal residences, capital gains that occur are exempt from
    taxation. It appears that other countries treat sale of homes differently,
    taxing people on such gains. German authorities, for example, tax those
    gains only if you owned the property for less than ten years.</para>

    <para>Chris Browne has a story from his professional tax preparation days
    where a family sold a farm, and expected a considerable tax bill that
    turned out to be virtually nil due to having owned the property before
    1971 (wherein lies a critical <quote>Valuation Day</quote> date in Canada) and due to
    it being a dairy farm, with some really peculiar resulting deductions. The
    point of this story is that while the presentation here is fairly simple,
    taxation often gets terribly complicated...</para>
  </sect1>
</chapter>
