accounting Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "languag ...

finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...

and

economics Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behaviour and intera ...

, an accounting identity is an equality that must be true regardless of the value of its variables, or a statement that by definition (or construction) must be true. Where an accounting identity applies, any deviation from numerical equality signifies an error in formulation, calculation or measurement. The term ''accounting identity'' may be used to distinguish between propositions that are theories (which may or may not be true, or relationships that may or may not always hold) and statements that are by definition true. Despite the fact that the statements are by definition true, the underlying figures as measured or estimated may not ''add up'' due to measurement error, particularly for certain identities in macroeconomics.

Description

The most basic identity in accounting is that the

balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...

must balance, that is, that

asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value ...

s must equal the sum of liabilities (debts) and

equity Equity may refer to: Finance, accounting and ownership * Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the dif ...

(the value of the firm to the owner). In its most common formulation it is known as the

accounting equation Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "language ...

: :''Assets = Liabilities + Equity'' where debt includes non-financial liabilities. Balance sheets are commonly presented as two parallel columns, each summing to the same total, with the assets on the left, and liabilities and owners' equity on the right. The parallel columns of Assets and Equities are, in effect, two views of the same set of business facts. The balance of the balance sheet reflects the conventions of

double-entry bookkeeping Double-entry bookkeeping, also known as double-entry accounting, is a method of bookkeeping that relies on a two-sided accounting entry to maintain financial information. Every entry to an account requires a corresponding and opposite entry to ...

, by which business transactions are recorded. In double-entry bookkeeping, every transaction is recorded by paired entries, and typically a transaction will result in two or more pairs of entries. The sale of product, for example, would record both a receipt of cash (or the creation of a trade receivable in the case of an extension of credit to the buyer) and a reduction in the inventory of goods for sale; the receipt of cash or a trade receivable is an addition to revenue, and the reduction in goods inventory is an addition to expense. In this case, an "expense" is the "expending" of an asset. Thus, there are two pairs of entries: an addition to revenue balanced by an addition to cash; a subtraction from inventory balanced by an addition to expense. The cash and inventory accounts are asset accounts; the revenue and expense accounts will close at the end of the accounting period to affect equity. Double-entry bookkeeping conventions are employed as well for the

National Accounts National accounts or national account systems (NAS) are the implementation of complete and consistent accounting techniques for measuring the economic activity of a nation. These include detailed underlying measures that rely on double-entry ...

. Economic concepts such as national product, aggregate income, investment and savings, as well as the balance of payments and balance of trade, involve accounting identities. The application of double-entry bookkeeping conventions in measuring aggregate economic activity derives from the recognition that: every purchase is also a sale, every payment made translates income received, and every act of lending also an act of borrowing. Here the term ''identity'' is a

mathematical identity In mathematics, an identity is an equality relating one mathematical expression ''A'' to another mathematical expression ''B'', such that ''A'' and ''B'' (which might contain some variables) produce the same value for all values of ...

or a logical tautology, since it defines an equivalence which does not depend on the particular values of the variables.

Identities in accounting

Accounting has a number of identities in common usage, and since many identities can be decomposed into others, no comprehensive listing is possible.

Inter-period identities

Accounting identities also apply between accounting periods, such as changes in cash balances. For example: :''Cash at beginning of period + Changes in cash during period = Cash at end of period''

Value of an asset

Any asset recorded in a firm's balance sheet will have a

carrying value In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Tra ...

. By definition, the carrying value must equal the historic cost (or acquisition cost) of the asset, plus (or minus) any subsequent adjustments in the value of the asset, such as

depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the a ...

. :''Carrying value = Historic cost + Change in value''

Economics

In economics, there are numerous accounting identities.

Balance of payments

One of the most commonly known is the

balance of payments In international economics, the balance of payments (also known as balance of international payments and abbreviated BOP or BoP) of a country is the difference between all money flowing into the country in a particular period of time (e.g., a ...

identity, where: :''Current Account Surplus + Capital Account Surplus = Increase in Official Reserve Account'' A common problem with the balance of payments identity is that, due to measurement error, the balance of payments may not total correctly. For example, in the context of the identity that the sum of all countries' current accounts must be zero, ''

The Economist ''The Economist'' is a British weekly newspaper printed in demitab format and published digitally. It focuses on current affairs, international business, politics, technology, and culture. Based in London, the newspaper is owned by The Econo ...

'' magazine has noted that "In theory, individual countries’ current-account deficits and surpluses should cancel each other out. But because of statistical errors and omissions they never do."

Gross domestic product

The basic equation for

gross domestic product Gross domestic product (GDP) is a money, monetary Measurement in economics, measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjec ...

is also an identity, and is sometimes referred to as the National Income Identity:"Macroeconomics", Auerbach and Kotlikoff, pp. 122-23, 1998 : ''GDP =

consumption Consumption may refer to: *Resource consumption *Tuberculosis, an infectious disease, historically * Consumption (ecology), receipt of energy by consuming other organisms * Consumption (economics), the purchasing of newly produced goods for curren ...

investment Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing i ...

government spending Government spending or expenditure includes all government consumption, investment, and transfer payments. In national income accounting, the acquisition by governments of goods and services for current use, to directly satisfy the individual o ...

+ (

export An export in international trade is a good produced in one country that is sold into another country or a service provided in one country for a national or resident of another country. The seller of such goods or the service provider is an ...

s −

import An import is the receiving country in an export from the sending country. Importation and exportation are the defining financial transactions of international trade. In international trade, the importation and exportation of goods are limited ...

s)''. This identity holds because investment refers to the sum of intended and unintended investment, the latter being unintended accumulations of inventories; unintended inventory accumulation necessarily equals output produced (GDP) minus intended uses of that output—consumption, intended investment in machinery, inventories, etc., government spending, and net exports.

Investment

:''

Investment Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing i ...

Fixed investment Fixed investment in economics is the purchasing of newly produced fixed capital. It is measured as a flow variable – that is, as an amount per unit of time. Thus, fixed investment is the accumulation of physical assets such as machinery, land ...

Inventory investment Inventory investment is a component of gross domestic product (GDP). What is produced in a certain country is naturally also sold eventually, but some of the goods produced in a given year may be sold in a later year rather than in the year they wer ...

'' :''Gross investment'' – ''Depreciation = Net investment''

Banking

A key identity that is used in explaining the multiple expansion of the

money supply In macroeconomics, the money supply (or money stock) refers to the total volume of currency held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include Circulation (curren ...

is: :''Bank assets = Bank liabilities + Owners' equity'' Here the liabilities include deposits of customers, against which reserves often must be held.

References

{{Reflist

External links

The Basic Accounting Identity
Financial accounting