Assets and Liabilities

Assets and Liabilities, in economics, an entity’s wealth with the debts and other claims made upon it. A crucial distinction is made in economics and accounting between flows and stocks. Income, for example, is a flow, and any figure of income needs to be accompanied by some time period—a week, or a month, or a year—to which the flow relates. One’s wealth, by contrast, is a stock. It needs to be accompanied by some indication of the date at which it was valued. In accounting practice, stock variables, such as wealth, are represented on a balance sheet. This will represent, on one side, the assets and on the other side the liabilities. What constitutes assets and liabilities will vary, however, according to the entity for whom, or for which, the balance sheet is drawn up.

For example, the assets of an individual might include his house, the contents of his house, his bank deposits, his less liquid financial assets (for example, the stocks and shares that he owns), and any cash that he happens to have left lying around. One might also include pension rights, which no doubt have a significant effect on household spending behaviour. An individual may also have various liabilities that would appear on the other side of his balance sheet. These could include, for example, any mortgage on his house, or the debt he has incurred on his car or other personal possessions, or other financial commitments, including his income tax liabilities.

At the level of the firm, the composition of assets and liabilities would be rather different. A firm’s assets would include, notably, its plant and machinery, its stocks (inventories) of raw materials or goods in the process of production or finished goods not yet delivered to customers. It should also include “receivables”, such as debts to the firm—for example, for goods delivered but not yet paid for—or income due on the firm’s holding of any financial assets. Firms will also usually be more valuable than the sum of the above items, for they will also expect to be able to earn income as a result of the existence of the firm as a going concern—that is, as a productive unit with customers. This is commonly defined as “goodwill”. On the liability side of the balance sheet, the firm will have its obligations to pay its suppliers and any other financial obligations—for example, outstanding tax liability. Also, insofar as it has issued debt to raise capital (that is, bonds as distinct from equity capital, or deposits in the case of banks) it has obligations to the holders of its bonds or its depositors.

At the level of a nation, the concepts of assets and liabilities change once more. A national balance sheet will not be simply the aggregation of the balance sheets of individuals and firms. A nation’s assets also include national capital, such as public buildings (public libraries, royal palaces, ministerial offices, and so on), and such parts of the transport infrastructure or certain natural assets (such as raw material deposits, forests, and so on), that may not be included on the balance sheet of any other entity. It is also arguable that since the most important asset of a nation is its labour force, some allowance should be made for this. Naturally, obligations and liabilities between firms and individuals in the same country will cancel out—one person’s liability to pay another will appear on the asset side of the latter. But a nation may own assets overseas (physical or financial) and foreigners may own some national capital (physical or financial). The national wealth, therefore, should take account of net liabilities to the nationals of other countries.

Contributed By:
Wilfred Beckerman

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