Financial Stability, + Website

CHAPTER 17 Accounting: Assets ≡ Liabilities + Capital

Accounting uses the laws of mathematics to express economics in a manner consistent with the legal obligation of firms and individuals to fairly report their financial condition when they provide financial statements.

Accountants are supposed to safeguard against fraud by making firms apply one measure consistently. While it follows general principles to achieve consistent reporting, accountancy’s only goal is to responsibly reflect conclusions from other sciences and fields. Failure to recognize this ancillary (though vitally important) function of accounting has contributed to abuses that create instability in finance.

The vitality of accounting lies in the power of the double-entry system that is the heart of this analytic tool. Every credit or debit must generate a corresponding entry in order to maintain the two essential balances expressed in financial statements: (1) assets must always equal the sum of liabilities and capital, and (2) revenues must always equal the sum of expenses and earnings. Finally, cash flows and inventories must accurately carry balance positions from one financial statement period to the next.

When transactions are reported in a manner that reflects accounting practice but fails to reflect the law, mathematics, and economics, then accounting practice must change to assure compliance. Since 1997, accounting standards have conformed transactions involving financial asset transfers to the law, ...