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Date: 2019-04-23 Page is: DBtxt001.php L0700-TVM-s2-about-the-Balance-Sheet


TRUE VALUE METRICS
ABOUT THE BALANCE SHEET


STATE / BALANCE SHEET

The Purpose of the Balance Sheet
STATE ... A Balance Sheet Shows State
The genius of accountancy is the concept of double entry, which in turn gives rise to the essential continuity between the balance sheet accounts and the profit and loss accounts. Putting it another way, double entry accounting is about measuring both state and flow in the same framework.
A balance sheet shows state at a specific moment in time. The balance sheet has been a core piece of financial accounting and reporting for a very long time … it is a big reason why accounting is such a powerful system of economic performance metrics.
The balance sheet is a financial representation of the “state” of the reporting entity … it reports on the condition of the entity, whether an organization, a nation or a community.
If you do not know where you are, it is difficult to know where you are going!
The Money Balance Sheet
Conventional financial reporting reports on the state of an organization using financial information in the form of balance sheet.
A for-profit entity has assets, liabilities and the owner's equity … that is the investors' equity. Not-for-profits also have money balance sheets that reflect the assets and liabilities of the entity based on money flows and resultant balances.
In conventional financial reporting, the balances report the aggregate of all the money transactions.
A Value Balance Sheet
A 'Value Balance Sheet' is a core piece of the True Value Accounting (TVA) framework of metrics. Instead of the balance sheet being only about money in TVA the balance sheet is about both money and value … including the present value of what the entity has done and will do for value in society.
Every entity that uses standard money accounting should also be using a comprehensive 'value' methodology like TVM's True Value Accounting (TVA). The TVA system works for all organizations whether or not they are for profit or not-for-profit, whether they are in the private sector or in the public sector, and whether or not they are large or small.

PROGRESS and PERFORMANCE
How STATE is the key to efficient cost effective measurement of PROGRESS and PERFORMANCE

The Relationship Between Original State, Period Activities and New State

The activities of the period do not change the state
... state at the end of the period (EOP) is the same as at the beginning of the period (BOP)
Simple balance sheet … the steady state situation
In this image, the value of the community is the same at the end of a period as it was at the beginning ... ordinary daily activities produce what is consumed ... it is a stable steady state situation.
The steady state situation is unusual. What is normal is either progress or regression. In this next case the value of the community is more at the end of a period than at the beginning of the period ... ordinary daily activities produce more than is consumed.
Balance sheet progress

The VALUE at the end of the period (EOP)is bigger than at the beginning of the period (BOP)
... this is PROGRESS
Balance sheet regression

The VALUE at the end of the period (EOP)is less than at the beginning of the period (BOP) ... this is VALUE DESTRUCTION
Many activities that result in MONEY PROFIT diminish HUMAN CAPITAL and NATURAL CAPITAL.
The overall result is VALUE DESTRUCTION.
In this last case the value of the community is the less at the end of a period than at the beginning of the period ... a problem because activities produce less than are consumed.

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Balance Sheet Thinking Should Apply Everywhere
STATE - the Value Balance Sheet of the ORGANIZATION
In the TVM framework, it is not only the organization that is the focus of analysis, but people and place or community as well. The value of economic activity is the improvement and maintenance of quality of life for people. Community is a place where people live, and a place has truly long term if not perpetual existence. Place is also a good proxy for planet, because what happens to the resources and environment in a place translates to impact on the planet.
STATE - the Value Balance Sheet of the PLACE
In the TVM framework, it is not only the organization that is the focus of analysis, but people and place or community as well. The value of economic activity is the improvement and maintenance of quality of life for people. Community is a place where people live, and a place has truly long term if not perpetual existence. Place is also a good proxy for planet, because what happens to the resources and environment in a place translates to impact on the planet.
Example of Okehampton in England
Facts like population and farms for my own little home town of Okehampton in Devon, England were recorded in the Domesday Book compiled by William the Conqueror shortly after his invasion of England in 1066. The population of the town did not grow much in almost 900 years!
STATE - the Value Balance Sheet of a PERSON
All of the same analytical ideas that are valid for an organization can also be applied to a PERSON. Every person has a history, a present and a future which can be summarized as the present STATE of the PERSON.
STATE - the Value Balance Sheet of a PRODUCT
All of the same analytical ideas that are valid for an organization can also be applied to a PRODUCT. Every product has a history, a present and a future which can be summarized as the present STATE of the PRODUCT

The Components of the Balance Sheet
Conventional GAAP Accounting True Value Impact Accounting
Assets, Liabilities and a 'To Balance' Number
A conventional financial accounting balance sheet has assets, liabilities and owner's equity as the 'to balance' number. All of the balances are computed by reference to money transactions. There are long established accounting rules about how the assets and liabilities are recorded and included in this financial reporting for the entity.
Assets, Liabilities and a 'To Balance' Number
In True Value Impact Accounting conventional financial accounting the balance sheet coninues to have assets, liabilities and owner's equity as the 'to balance' number related to the financial transactions and the related financial capital. All of the these balances are computed by reference to money as the unit of account. There are long established accounting rules about how the assets and liabilities are recorded and included in this financial reporting for the entity.
In addition to the financial accounting balances, there are changes in the value of ALL the capitals as set out below. Each of these changes in capital are accounted for using the unit of account for the capital. The accounting for different units of account is analogous to the accounting methods used for multi-currency accounting in conventional financial accounts.
Assets
The resources of the entity are an important part of the foundation for the progress of the entity. Though the entity may not have a lot of financial capital, there may be many other resources, including human resources and natural resources that are important components of sustainable progress.
There are 7 main asset elements with both money and value dimensions (see below)
Liabilities
Constraints and “lack of” are treated as liabilities in the value balance sheet. While money liabilities have the same form in both money and value balance sheets, the value of activities and issues that constrain progress and performance of the community are the treated as value liabilities. The 7 liability elements mirror the value assets (see below)
To Balance ... Cumulated Value or Value Destruction
Assets less Liabilities is Net Assets or the resultant value

Main Elements of the Balance Sheet
Conventional GAAP Accounting True Value Impact Accounting
Working Capital ... Cash
Cash usually includes certain highly liquid securities.
There may be questions about value arising because of issues like exchange control and taxation when the cash is transferred between different tax jurisdictions.
Working Capital ... Cash
On the balance sheet of the reporting entity, cash as a store of value only has a financial dimension

Financial Capital … money and financial resources
As assets
Money resources are important. Money is needed to serve as a medium of exchange, and to some extent a store of value. But the biggest reason for money resources is to pay salaries and to pay bills and to be part of the broad money economy. Without money an organization has to close down or go into a dormant state. Good ideas disappear when there is not money to sustain a framework for the ideas to develop and perhaps flourish. Almost everything that is needed, whether goods or services must be paid for with money … or money equivalent.
Credit is a money equivalent, up to a point. The assumption is that money will be available in the future … and if this proves to be wrong, then the “credit” disappears.

Liability is a lack of these things
The lack of capital ... money, financial resources … and the lack of credit is a constraint and recorded as a liability
Working Capital ... Accountants Receivable
Working Capital ... Accountants Receivable
Working Capital ... Inventory
The basic accounting is based on cost calculations. There are two possible approaches: one is FIRST IN FIRST OUT (FIFO) and one is LAST IN FIRST OUT (LIFO). When costs are increasing, the LIFO calculation results in a higher cost of sales (COS) and a lower inventory value, while the FIFO calculation results in a lower cost of sales (COS and a higher inventory valuation. This has an impact on profits and related taxation.
Working Capital ... Inventory
In True Value Impact Accounting the inventory computation reflects not only the financial costs but also the accumulated impact of creating the inventory through the supply chain and reflecting the impact on every element of capital of the complete socio-enviro-economic system.
Money cost (Financial Capital impact) associated with:
... FC - Products / Materials
... FC - Labor
... FC - Equipment / Process
... FC - Admin, Marketing and General
... FC - Research and Development
... FC - Taxation
... FC - Pro-bono Expenditures
... FC - Accumulated Profit
Impact associated with Human Capital:
... HC - Human Capital / life (demography)
... HC - Human Capital / contribution
... HC - Human Capital / cost of living
Impact associated with Natural Capital:
... NC - Land
... NC - Water
... NC - Air
... NC - Carbon circulation
... NC - Ecosystem Services
... NC - Fauna and Flora
... NC - Mineral Resources
... NC - Fossil Fuel Resources
Impact associated with People Built Systems and Structures (PBSS):
... PBSS - Physical Capital
... ... PBSS Physical Capital - Privately Owned
... ... PBSS Physical Capital - Owned Communally
... PBSS - Intangible Capital
... ... PBSS Intangible Capital - Government / Enabling Environment
... ... PBSS Knowledge / IP - Privately Owned
... ... PBSS Knowledge / IP - Owned Communally
Working Capital ... Prepayments and Other
Working Capital ... Prepayments and Other

TOTAL WORKING CAPITAL
TOTAL WORKING CAPITAL
.
.
FIXED ASSETS
FIXED ASSETS
Fixed assets - Land
The basic accounting is based on a historic cost calculation.
Because the market value of land has changed (... usually an increase) substantially over the years, from time to time an entity may choose to 'revalue' land based on the prevailing market value. This must be fully disclosed in the financial reporting to stockholders.
Land … Natural resources
As assets
Land and natural resources have been important drivers of wealth creation … and in large part the history of wealth is also the history of natural resource exploitation. Natural resources in a community should be considered as important assets of the community. There are a host of issues associated with natural resources and their use for the benefit of the community. Many of these are constraints that impact the community and the opportunity of the community to make socio-economic progress.
Land is an important natural resource
... Forest and trees are important
... Rivers and water are important
... Minerals resources are important
... Energy resources are important
... Access to Sun, Wind and Tide may have value
There are many different resources. In classical economics where agriculture and trade were the dominant economic activities, the resources needed for economic activity were identified as land, labor and capital. Modern economics builds on these ideas and the role of many intangibles is now taken into account in a more complete manner.

Liability is a lack of these things
A community is constrained when it does not have enough land and natural resources. A community may adapt … but it may not.
Labor … People / human resources
As assets
In money accounting, people are not part of the balance sheet, though their performance makes a huge difference in profit performance. In the TVM framework people are reported as the asset they are.
There has to be care in the handling of data about people which may be constrained by legal issues of one kind or another. Many facts about people may not be shared in the public space because of law and regulation.
People are very important. Especially in the community … without people there is no community. It is people that are the beneficiaries of quality of life and opportunity. People are also the source of labor, creative ideas and intangibles like friendship. People are family … and people are community! People are the most important resource in any place … way more important than money.
What value is a person? What value is education until it is part of a person's capacity. So also what is the value of good healthcare unless it is part of a person's capacity. And what value is a person unless there is opportunity to do something of value with the person's capacity! There are multiple attributes that go into building the value of people in society. The value of a person can be quantified based on the various attributes of the people and the community.
Sustainable socio-economic progress depends on people … human capacity and the human resource more than any other resource. In the end, the human resource is the one that will facilitate or constrain progress and performance. The key, therefore is to enable people to be the energy that drives socio-economic activity and the production of goods and services. In a modern society, it is people who get benefit, but it is also people who work to produce the benefit. A program that has people focus and has a dynamic that is people centric can be sustainable.
People define the needs … and people are the most important resource. When this is the thinking behind the way the planning is done, development becomes an investment with a return and not merely an expenditure. Modern economics recognizes the dual role of people … as people with needs … and as people that produce to satisfy needs. In other words, people are more than merely a factor of production, they are also the driver of demand.

Liability is a lack of these things
The lack of labor ... people, human resources is a constraint. The lack of labor is a liability … the lack of capacity in the population is a liability. If people are a valuable resource, the lack of people is a constraint and a liability. The constraints associated with the population are a function of matters like the history of nutrition and health, the history of education and the history of the community.
Physical capacity … buildings, infrastructure, etc.
As assets
There are two levels of value associated with buildings (1) the satisfaction of the basic need for shelter; and (2) the buildings needed to support quality of life and the productivity of society.
The basic need for shelter is very important in the present circumstance of Haiti. With as many as 250,000 housing units destroyed in the earthquake there is a very large need for basic shelter.
Many of the major commercial and governmental buildings have to be rebuilt
Roads and bridges determine the efficiency of transport.
Internet and telephone infrastructure determines the efficiency of communications
Various types of equipment determine productivity in the activities of the society
Working capital is part of this. Business activity needs working capital … inventory and the ability to finance trade transactions.

Liability is a lack of these things
The lack of physical capacity ... infrastructure, production capacity, organization … is a liability.
Knowhow … intellectual capacity
As assets

Science and technology … know-how
Know-how is a key enabler of progress. In fact it is the growth of knowledge over the past 200 years that has made it possible for global society to progress so rapidly. The growth in knowledge has been far more rapid than the growth in the application of knowledge. Worse, the application of knowledge has been for both bad and good.
Enabling environment: Governance, Rule of law
Liability is a lack of these things
The lack of intellectual capacity … science and technology, know-how, and an enabling environment are liabilities
Organizational capacity

As assets


Organizational capacity contributes to economic productivity. Organizational capacity has value … it is very important in making it possible for the economic activity of the community to be productive. Productive economic activity is surplus producing and helps a community progress.
An individual is very limited in what he or she can do alone … but when individuals work as a team all sorts of amazing things can get done. Organization is needed so that things can get done … and organizations are a way for organization to take place. It is organizations that do things, create jobs and make it possible for there to be progress.
Organization is needed to have productive activities. Most activities may be initiatives of the private sector … private organizations, and using private capital. In a functioning economy most activities are paid for by the beneficiaries of the activities.
Being organized is an asset. The challenge is to be organized so that there is a structure within which (1) there can be financing; (2) there can be wage employment; and, (3) there can be socio-economic value adding.
There are many legal forms that are possible … depending on the prevailing legal framework and the way the community wants to be organized or structured. From an accountant's perspective the key elements are: (1) the funding of working capital so that wages can be paid; (2) the balance sheet value improvement that results from the work done and the payment of wages; and, (3) the monetization of the value improvement so that the funds mobilized may be repaid or recirculated.
Liability is a lack of these things
Liability is the lack of organization … organizational capacity
Governance and the enabling environment

As assets


Governance is a matter that may facilitate the progress of a community or constrain it ... governance may therefore be an asset or a liability. Governance is an asset when it provides an enabling environment for progress ... otherwise it is a liability.
Money liabilities are amounts owed by the entity to others ... a fairly simple concept.
The concept of liability in value terms is more nuanced. Essentially a liability is a lack of an important asset needed to satisfy community needs.
Liability is a lack of these things
There are two ways in which constraints are manifested: (1) by specific things that stop activities or limit productivity; and, (2) by the lack of things that are needed to have productive activities in the community. Crime is a specific thing that stops activities and limits productivity. Lack of land, for example, constrains agricultural activity.
In TVM value accounting there is value in having the capacity to satisfy needs ... that is Tier 1 needs. Conversely there is a value liability when such capacity does not exist. The same analytical logic applies to all the types of capacity.
The lack of governance and enabling environment
Off Balance Sheet Items
The money accounting rules have been changed over time so that many important financial matters are routinely excluded from balance sheet reporting. This is a dangerous state of affairs brought about by “law based” money accountancy that allows wrong principled reporting to take place. It is very convenient for business organizations to be able to legally lie about the financial condition of the organization.
Unrecorded liabilities
Unrecorded liabilities like pension payment commitments is a major issues in the reporting of STATE and done this way for the convenience of politicians and business leaders rather than being done in a complete and correct way that truly reflects the reality.
Contingent liabilities
But the concept is less clear when there is conditionality about what is to be paid and where the calculations are complex. Liabilities that might be very large when a set of conditions apply, but may not exist at all if other conditions apply create a huge risk for anyone relying on financial analysis of the entity.
I was part of an investment group that almost acquired a shipbuilder in Florida. There was a good business plan and the future of the acquired organization looked good ... but there was one problem. The shipbuilder built mainly fishing trawlers, and there was the potential for a lawsuit related to one of the company's trawlers sinking in a storm in the Atlantic with loss of life. While all the normal insurance protections were in place ... there was a small possibility that there might be a counter-claim about a deficiency in design, or something along those lines. Even though several hundred vessels of this or similar design were in use ... this contingent liability was sufficient to stop this transaction from closing.
Risk
Change is a risk … and a poor community is likely to be risk averse for good reason. The matter of risk must be taken into consideration and risk managed appropriately.
It should be noted that “risk” is an issue that is almost totally ignored by the wealthy who one might say “self insure” and do not get hurt very much when things go wrong … while the poor have to endure even more hardship when risks hit society, and they are caught up in the damage that ensues.
Land ... natural resources;
Labor ... people, human resources;
Capital ... money, financial resources;
Physical capacity ... infrastructure, production capacity, organization;
Intellectual capacity … science and technology, know-how, enabling environment;
Organizational capacity; and
Governance and the enabling environment.

Value balance sheet starts with money balance sheet elements … but the quantification of the elements is not the same. TVM includes the value of the elements in the balance sheet as well as the cost
The lack of land ... natural resources;
The lack of labor ... people, human resources;
The lack of capital ... money, financial resources;
The lack of physical capacity ... infrastructure, production capacity, organization;
The lack of intellectual capacity … science and technology, know-how, enabling environment;
The lack of organizational capacity; and
The lack of governance and the enabling environment.

Constraints are liabilities in the value balance sheet. Constraints may be either an active limit on what progress may be achieved, or something passive like the lack of something that is critical. Examples of active constraints may be the enabling environment, the framework of law and insecurity. Examples of passive constraints may be lack of water, lack of money, lack of infrastructure, and so forth.



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