11. Balance sheet and net worth

In: A Primer in Monetary Economics

13 Aug 2011

By: Andrea Terzi

Assets and liabilities

In a double entry ledger book, debits reflect acquisitions of value and credits reflect releases of value. This information offers a source for preparing some key documents that show how the activities of giving and receiving shape monetary values.

One such document is the balance sheet. This is a means to measure, at a specified point in time and in one single unit of account, all the values that a given economic unit owns (called assets) and all the values that it owes (called liabilities). The connection with the ledger is that both an increase of assets and a decrease of liabilities result from an acquisition of value (i.e., a debit entry), while both an increase of liabilities and a decrease of assets result from a release of value (i.e., a credit entry).

For a given economic unit, however, not all entries in the ledger (where debits match credits) will show on the balance sheet. One reason is that because it refers to a given point in time, a balance sheet reflects the net results of past ledger entries. For example, a loan that has been fully repaid will not show. Neither will the value of a property that has been purchased and resold.

In addition, there are three reasons for which the value of all assets and of all liabilities need not match:

a) The value of assets and/or liabilities may change, independently of transactions. For example, a U.S.-based company’s liability in euros will fall if the dollar price of euros falls; the value of a property will fall if the expected selling price  decreases.

b) Assets and/or liabilities may evaporate. For example, fire may destroy an uninsured property, a liability may be canceled, and any values that the economic unit has received, but meanwhile consumed, will not appear—such as when a business acquires labor services or a household acquires consumer services, neither of which can be stored.

c) New liabilities and new assets may materialize without being linked to specific ledger book entries. For example, a new liability appears when a new tax is imposed by the state or the judicial system. And a new asset appears when the economic unit creates a value internally (i.e., not obtained from others), such as semi-finished and finished products stored as inventories by business.

Net worth

The difference between the value of assets and the value of liabilities is called net worth and is a measure of the accumulated stock of wealth of the economic unit. If this is a business, it is called the owner’s (or shareholders’) equity.

Figure 2 shows the key broad entries of a typical balance sheet. While liabilities are obligations that entail future payments to other parties, assets are things that have value and are normally expected to generate cash inflows, as well as cash outflows. For business, real assets include investment goods like plants and equipment, unfinished products, and other inventories. For households, they include property that retains a reselling price.

Figure 2. Structure of a balance sheet

ASSETS (net increase in debits) LIABILITIES (net increase in credits)
Real assets Financial liabilities
Financial assets
Net worth (= Assets – Liabilities)

Financial accounting techniques, principles, standards, and rules

An economic entity’s balance sheet is of significance to all users interested in monitoring that economic entity’s performance, and the study of financial accounting techniques and principles helps enhance the accuracy of accounting records. Audits ascertain the validity and reliability of information. Because those who have direct knowledge and ownership of the ledger may not have an interest in sharing it with others or may have an interest in showing inaccurate or deceitful statements, accounting standards and regulations set principles and rules on how businesses should compile their balance sheets and how they must disclose them to third parties.

Next module: Income statement and net income
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2 Responses to 11. Balance sheet and net worth

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Barb Baco

June 17th, 2012 at 21:02

assets = liabilities + owner equity
assets – liabilities = owner equity

opening investment
debit cash
credit owner equity
both go up in value

it is about the side of the t account
credits do not release value

I am a bookkeeper
the inaccurate use of these terms is very frustrating
because I want to be able to explain this in REAL terms
I hesitate to recommend this to any of the accountants I work with
because it makes every thing else suspect

I am reading hundreds of pages of mosler and mitchell and company
in order to understand the mechanics…..
and the political power of sovereign money…..
this amateur balance sheet reading made me cringe.

please get some help from a real bookkeeper…..

thanks
Barb Baco

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aterzi

June 17th, 2012 at 23:02

Barb Baco:

I wish you could provide useful criticism, and I look forward to it.

1. Your assets = liabilities + owner equity
is identical to this module where the more general term ‘net worth’ is used instead.

2. If I sell a house (i.e., I ‘release’ value), the value of the house goes under credit. The money I receive (i.e., my ‘acquisition of value’) goes under debit.

It may be different doing accounting professionally and teaching it.
Yet, I don’t see what your critique is.

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