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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 could increase in value, some 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 (for example, 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 &app;.
    </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>

    <important>
      <para>In the next few sections, unrealized gain accounts are created, and the estimated unrealized gain
        transactions are recorded there in order for users to understand unrealized gain easily.
        However, it is not necessary to record unrealized gains unless large corporations like which
        adopt IFRS in actual accounting. The small enterprise users, who are using &app;, should not
        record unrealized gains. Record into &app; only when realized gains are fixed.
      </para>
    </important>

    <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 asset <emphasis>Cost</emphasis> account
      (&app; 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</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>
<screen>
-Assets
    -Current Assets
        -Savings
    -Fixed Assets
        -ITEM1
            -Cost
            -Unrealized Gains
        -ITEM2
            -Cost
            -Unrealized Gains
-Income
    -Realized Gains
    -Unrealized Gains</screen>
  </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 that shown in <xref
    linkend="capgain_accounts1" />,
      but replace <emphasis>ITEM1</emphasis> with <emphasis>Degas</emphasis> and remove the
      <emphasis>ITEM2</emphasis> 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>

    <figure pgwide="1">
      <title>Asset Appreciation Main Window</title>

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

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

    <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>Income:Unrealized Gains</emphasis> account to your <emphasis>Assets:Fixed
        Assets:Degas:Unrealized Gains</emphasis> account. Your main window will resemble this:
      </para>

      <figure pgwide="1">
        <title>Asset Appreciation Main Window</title>

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

            <caption>
              <para>Chart of Accounts after unrealized gain
              </para>
            </caption>
          </mediaobject>
        </screenshot>
      </figure>
    </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>overestimated</emphasis> the unrealized gain, or
        <emphasis>underestimated</emphasis> the unrealized gain.
      </para>

      <orderedlist>
        <listitem>
          <para><emphasis>Accurate estimation</emphasis> of unrealized gains.
          </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</emphasis>, and the full <emphasis>Assets:Fixed
            Assets:Degas:Unrealized Gains</emphasis> into <emphasis>Assets:Current
            Assets:Savings</emphasis>.
          </para>

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

          <para><table>
              <title>Turning an Unrealized Gain into a Realized Gain - Accurate Estimation</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
                    </entry>

                    <entry>
                      $100,000
                    </entry>

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

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

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

                    <entry>
                      $30,000
                    </entry>

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

          <para>This leaves the <emphasis>Assets:Current Assets:Savings</emphasis> account with a total of $130,000
            and <emphasis>Income:Realized Gains</emphasis> with a total of $30,000.
          </para>

          <figure pgwide="1">
            <title>Asset Appreciation Main Window</title>

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

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

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

          <para>You were over-optimistic about the value of the painting. Instead of the $130,000 you thought the
            painting was worth you are only offered $120,000. But you still decide to sell, because
            you value $120,000 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> account):
          </para>

          <para><table>
              <title>Turning an Unrealized Gain into a Realized Gain - Over estimation</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
                    </entry>

                    <entry>
                      $100,000
                    </entry>

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

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

                    <entry>
                      Assets:Current Assets:Savings
                    </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</emphasis> account with a total of $120,000
            and <emphasis>Income:Realized Gains</emphasis> with a total of $20,000.
          </para>
        </listitem>

        <listitem>
          <para><emphasis>Under estimation</emphasis> of unrealized gains.
          </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, that is an income.
          </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 Unrealized Gain into a Realized Gain - Under estimation</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
                    </entry>

                    <entry>
                      $100,000
                    </entry>

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

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

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