Monday, 9 January 2012

A Double Entry View on the Keen Circuit Model

Over the last few months I've enjoyed Steve Keen's lecture series on You Tube, which are definitely recommended for anybody wanting a solid understanding of why neo-classical macroeconomics is complete bunkum.

In there is an iteration of Steve's horizontal money circuit and the tables and equations he uses to build that model. He's rejigged those models in response to a challenge by Scott Fullwiler to fit the model into double entry bookkeeping tables.

Now Steve is a great speaker, a good writer and formidable mathematician. But I'm afraid he would get a fail in a bookkeeping exam. For something to be consistent with double entry there has to be at least two entries in the journal and the journal must sum to zero. To abuse Minsky’s words: a double entry model with a single entry in it isn’t a double entry model.

So its easy to see why the presentation of this particular model causes a few fireworks in schools of thought who are more fastidious in their bookkeeping.

My background is in Information System design and architecture, with a dose of accountancy thrown in for good measure, and I’ve worked in and around the Free Software movement for over twenty years. So my natural tendency is to look at ways of re-integrating ‘forks’. I believe all the issues commonly complained about in this model can be reconciled by making the tables double entry complaint and extending the model slightly. I hope this will show to all sides that they are talking about the same thing.

And by doing so I am almost certain to upset everybody. Such is life.

First the current tables. This is a copy of table 14.1 in Debunking Economics (similar to table 1 on this post at Steve's site):

Assets
Liabilities
Equity
Operation
Vault
Loan Ledger
Firms
Workers
Safe
Lend Money
-Lend Money
+Lend Money
Record Loans
+Lend Money

Charge Interest
+Charge Interest

Pay Interest
-Charge Interest
+Charge Interest 
Record Payment
-Charge Interest
Deposit Interest
+Deposit Interest
-Deposit Interest 
Hire Workers
-Wages
+Wages
Bankers Consume
+Bankers Consumption
-Bankers' Consumption 
Workers Consume
+Workers' Consumption
-Workers' Consumption
Loan Repayment
+Loan Repayment
-Loan Repayment

Record Repayment
-Loan Repayment


From a double entry viewpoint there are a few things that feel uncomfortable with this table.
  1. the liabilities side is strictly the wrong sign. Liabilities are generally shown negative so that when you add them to assets you get zero. You can run them as a positive balance but that means the check of simply making sure the row adds up to zero doesn’t work so well (you have to multiply the sum of liabilities by -1 first). Also '-' is generally a credit and '+' a debit. So in the table you can see that firms appear to pay wages by 'crediting' and workers receive wages by 'debiting' which is inconsistent with the way bank accounts are usually described.

  2. The bank only gets paid when the firm pays the interest. Yet in accounting the bank will ‘recognise’ the income (ie credit its profit and loss account) as soon as it charges interest and this will allow it to spend before it gets paid. This isn't seigniorage as the bank has indeed earned that money. So the table has a minor temporal error in it which may or may not be important.

  3. The initial conditions on a balance sheet must be created by a series of journals and must balance to zero. Money shouldn’t magically appear in a Vault.

  4. But most importantly there are a lot of single entries in the rows. That makes this table inconsistent with the fundamentals of double entry that requires every transaction to sum to zero. To be double entry there must be at least two entries and the journal rows must sum to zero - or it is not a double entry table. So there is something missing from this model to balance those lines.
Bear in mind that this is a limited horizontal circuit model with a lot of heuristic assumptions. It is has static parameters and ignores everything other than a simple private credit circuit. So there is no initial capital for the bank or equity considerations and all the parameters have a fixed value. Those are all deliberate.

It’s job is to show that a private credit circuit with a fixed stock of money can exist standalone which was, prior to Steve's work, thought impossible.

My job is to reconcile this table so that it works from a double entry viewpoint, still have loans creating the equivalent deposits and have them both destroyed and not destroyed at the same time all while satisfying as many viewpoints as possible.

In other words the perennial accountant’s dilemma - how to present a set of accounts.

So let’s have a go at fixing this and see how many people we can upset.

Let’s start with the first line and fix the signs. We're going to impose a 'all rows sum to zero' restriction on this table.

Assets Liabilities Equity
Operation Vault Loan Ledger Firms Workers Safe
Lend Money +Lend Money -Lend Money

So we have an accurate journal on the firm side - crediting their account with money is definitely correct. But the balancing entry now appears wrong - why would crediting a Firm account increase a vault asset?

Answer: it wouldn’t. Vault is on the wrong side of the balance sheet. Paper notes in a Vault are a stock of non-circulating bank liabilities - as are the electronic equivalent. So let’s move Vault.

Assets Liabilities Equity
Operation Loan Ledger Vault Firms Workers Safe
Lend Money +Lend Money -Lend Money

Now it makes sense, the flow is moving the liabilities from the non-circulating stock in the Vault to the circulating stock at the Firm.

Which then leads onto the next question. How are there any liabilities in the Vault in the first place?

Well, thinking in paper for a moment, notes have to be made and there will be a limit to how many can be made. And only banks can make these notes, not firms. So what’s the difference?

The banks have a 'licence to print money' that the firms don’t have  (even if its one they gave themselves - as a truly independent central or private bank would do for example). Technically of course this is a 'licence to create money' - they are not required to print it. A licence is an ‘intangible asset’. The value of the licence to create money will vary over time depending upon the terms of the licence, the amount of outstanding loans and various other factors. And, like the intrinsic goodwill of the firm or its ‘human resources’, you don’t usually see the value on a bank balance sheet.

But in this model we want to know how much ‘potential money’ is in the system at any point in time so let’s add in a journal to give the bank the ability to create a fixed amount of money (remember this model is operating under fixed parameter heuristic assumptions). This neatly solves the problem of where the ‘initial value’ comes from and makes new money and old money the same thing - the value of the licence can vary dynamically like any other variable.

Assets Liabilities Equity
Operation Licence Value Loan Ledger Vault Firms Workers Safe
Grant Licence +Grant Value -Grant Value
Lend Money +Lend Money -Lend Money

And then finally add in the recording of the loan.

Assets Liabilities Equity
Operation Licence Value Loan Ledger Vault Firms Workers Safe
Grant Licence +Grant Value -Grant Value
Lend Money +Lend Money -Lend Money
Record Loan -Lend Money +Lend Money

So now we have an extended balance sheet with the money creation system declared explicitly on the face of the balance sheet. A credit licence has value and that initial value is added to the balance sheet as a non-circulating intangible asset and the associated non-circulating revaluation reserve liability - which we have called Vault in this model for want of a better name.

Issuing Loans reduces the remaining value of the credit licence and at the same time the Deposit reduces the remaining amount in the Vault. Loans still create deposits - but by changing non-circulating liabilities into circulating ones.

So far so good. Let’s add some interest.

Interest can be seen as an extension to the loan, where the associated deposit is immediately paid over to the Bank. So we can add that in.

Assets Liabilities Equity
Operation Licence Value Loan Ledger Vault Firms Workers Safe
Charge Interest +Interest Charge -Interest Charge
Record Interest -Interest Charge +Interest Charge

Generally there is no separate paying of interest. As anybody who has a mortgage knows you just make one repayment which covers the principal and accrued interest.

But this is really a stylistic point at this stage as the value of the payment is the Loan Repayment + Interest Charge anyway.

Assets Liabilities Equity
Operation Licence Value Loan Ledger Vault Firms Workers Safe
Repay Loan and Interest -Loan Repayment ‑Interest Charge +Loan Repayment +Interest Charge
Record Loan and Interest Repayment +Loan Repayment +Interest Charge -Loan Repayment ‑Interest Charge

So the revised Lending table looks like this in total:

Assets Liabilities Equity
Operation Licence Value Loan Ledger Vault Firms Workers Safe
Grant Licence +Licence Value -Licence Value
Lend Money +Lend Money -Lend Money
Record Loan -Lend Money +Lend Money
Charge Interest +Interest Charge -Interest Charge
Record Interest -Interest Charge +Interest Charge
Repay Loan and Interest -Loan Repayment ‑Interest Charge +Loan Repayment +Interest Charge
Record Loan and Interest Repayment +Loan Repayment +Interest Charge -Loan Repayment ‑Interest Charge


As a check let’s remove the intangible asset and associated journals from the balance sheet and see what we get:

Assets Liabilities Equity
Operation Loan Ledger Firms Safe
Lend Money +Lend Money -Lend Money
Repay Loan and Interest -Repayment +Repayment
Charge Interest +Interest Charged -Interest Charged

Which should look familiar to anybody on the MMT side of the debate.

That’s the bank lending items sorted. Let’s adding the spending elements and complete the circuit. So for the expanded balance sheet the final table looks like this:

Assets Liabilities Equity
Operation Licence Value Loan Ledger Vault Firms Workers Safe
Grant Licence +Licence Value -Licence Value
Lend Money +Lend Money -Lend Money
Record Loan -Lend Money +Lend Money
Charge Interest +Interest Charge -Interest Charge
Record Interest -Interest Charge +Interest Charge
Repay Loan and Interest -Loan Repayment ‑Interest Charge +Loan Repayment +Interest Charge
Record Loan and Interest Repayment +Loan Repayment +Interest Charge -Loan Repayment ‑Interest Charge
Pay Firm Deposit Interest -Firm Interest +Firm Interest
Pay Worker Deposit Interest -Worker Interest +Worker Interest
Hire Workers +Pay Workers -Pay Workers
Workers' Consumption -Workers' Consumption +Workers' Consumption
Bankers' Consumption -Bankers' Consumption +Bankers' Consumption

Write out the intangible assets and you get this:

Assets Liabilities Equity
Operation Loan Ledger Firms Workers Safe
Lend Money +Lend Money -Lend Money
Charge Interest +Interest Charge -Interest Charge
Repay Loan and Interest -Loan Repayment ‑Interest Charge +Loan Repayment +Interest Charge
Pay Firm Deposit Interest -Firm Interest +Firm Interest
Pay Worker Deposit Interest -Worker Interest +Worker Interest
Hire Workers +Pay Workers -Pay Workers
Workers' Consumption -Workers' Consumption +Workers' Consumption
Bankers' Consumption -Bankers' Consumption +Bankers' Consumption

So as you can see the balance sheets that 'create' and 'destroy' horizontal money are consistent with the one where horizontal money merely changes state to dormant, and the difference is simply to introduce an accounting policy requiring an intangible asset to represent potential loan capacity that currently isn't in circulation.

This is a very similar to the approach taken in accounting under IFRS 3 when reporting purchased goodwill. Prior to 2005 purchased goodwill was written out of the balance sheet and essentially combined with the intrinsic goodwill of the purchasing business. After 2005 it had to be carried explicitly on the face of the balance sheet. To get to the prior position you just take a IFRS 3 compliant balance sheet and write out the carried goodwill.

But what benefit does carrying the amount of ‘potential loans’ give us in the model? Well it helps to show how ‘hungry’ a bank is to lend. A bank with a high valuation on its credit licence has a lot of capacity to make loans, whereas one with a low valuation hasn’t. It is very likely that the first is going to be selling loans as hard as its can whereas the second is more likely to be putting its efforts into lobbying regulators to relax the cap on its lending capacity.

As I see it, the key point from the expanded model is that although it is easy to add credit potential to a system, it is somewhat more difficult (and may even be impossible in practice) to get rid of it again as it embeds itself deeply into the dynamic structure of the system.

In addition, by explicitly recording the value we can graph it over time and see how close to potential the economy gets, and as the model evolves we can compare dynamic caps on the credit licence to static caps and see what effect they have. Particularly as our current credit licences in the real world are linked to the amount of ‘regulatory capital’ a bank has and are therefore dynamic in their own right.

So whether you use an expanded balance sheet for your horizontal circuit or a collapsed one depends on what you’re trying to find out with your model.

I've created the double entry model using the QED program from Steve's site (which is based on the simplest stable model created in Steve's crash course lecture.). QED likes to see things positive (or it suffers an assertion failure), so the liability side has all been multiplied by -1 compared to the tables above.

The double entry model converges nicely and ends up looking like this (click for the full size version):


Whereas the original model ended up like this:


As you can see the figures converge to the same value - demonstrating that they are the same model at this level of dynamism. The double entry version shows the circulation between the assets and the liabilities happening separately (although in step of course) once the credit licence has created the initial stock of credit money. And if you add up the pots in each circulation at any point in time the total stocks should be the same value. The balance sheet now balances as it should.

31 comments:

Dimm said...

Hi Neil,
How does it compare to Godley/Lavoie ?

10x

Talvez... said...

That guy was on BBC telling how the Government should make more money of its own to help de-leveraging the private sector.

Other than that, I must re-read your post. I wish I understood accounting.

STF said...

Nice job, Neil.

For the record, I was not arguing that Steve's model was wrong--only that his accounting was wrong. I've never had any problem with the dynamics or results of the model, only the presentation. I think he misinterpreted me and believed I was saying both.

Best,
Scott Fullwiler

Neil Wilson said...

Scott,

It wasn't your criticism directly as much as many others dismissing Steve's work due to the bookkeeping.

Now I've removed that objection we can move on to the substantive debates.

We need to get all this pulled together into a coherent overall model.

Steve's up for it. I hope you are too.

Steve Roth said...

I am *very* excited by this post. I can think of no more salutary development in the field of economics than a Steve Keen/MMT convergence. To my knowledge Steve is the only one who is encoding a Godley-esque model in a dynamic simulation. It seems like MMTers should be all over that, devoting serious energy to helping him build out that simulation conceptually, algorithmically, and programmatically.

While from my limited perspective the single/double-entry contention may have been a bit of a sideshow, I could certainly be wrong.

But certainly: it has been an acrimonious debate in some quarters, an acrimony that seems to have hindered the convergence for years.

Thanks, Neil!

Steve Roth said...

To add:

"helping him build out that simulation"

Which is exactly what Neil has done here.

beowulf said...

So now we have an extended balance sheet with the money creation system declared explicitly on the face of the balance sheet. A credit licence has value and that initial value is added to the balance sheet as a non-circulating intangible asset and the associated non-circulating revaluation reserve liability - which we have called Vault in this model for want of a better name.

So this adds the vertical circuit that was missing from Keen's model?

Senexx said...

I didn't get that as the take-away from this post Beowulf.

It seemed to show more sympathy for Keen's version that the State has little involvement (which I believe is the beef he has with the Chartalists/MMT)

I do note that the model/s actually look like a circuit now rather than an incomplete circuit and a circuit. (Though I find reading the models dense)

I'm happy to be shown wrong if that was the intended take-away but I need to be led to water in the most layman way possible.

JKH said...

I'll take your word for it that you've converted Steve's model to double entry book keeping.

But its quickly obvious that this format has little to do with how bank accounting actually works in the real world - perhaps because of the absence of vertical, but likely for other reasons as well.

Where's this going?

Neil Wilson said...

There's no vertical in here. It's entirely horizontal.

This is just to correct the bookkeeping in the original Keen model so that it shows the dynamic flow in the asset and the liabilities side consistent with the rules of bookkeeping.

So you have loan capacity moving from dormant to active on the asset side and liabilities moving from non-circulating to circulating.

Not sure where the next step will be, but I want to see model evolving so that we can derive it from the systems in place at a real lending bank and vice versa.

What is here is very simplistic to prove one particular point - an idealised private circuit can pay for itself.

Getting from this to a real banking model is a fair bit of work I'd say - but we need it.

JKH said...

By all means, carry on. I only point this out because I’m not certain that you are fully aware that it’s the case or not. I assume you are. That’s why I’m interested in knowing where this is all going. For example, I can’t imagine what you’re going to do if and when you attempt to integrate the vertical from this point you’re at now. It would seem to me that a lot of this pre-vertical accounting reconciliation you’ve achieved will have to be jettisoned as irrelevant. E.g. I don’t know why anyone would prefer to model “vault entries” on the liability side of a commercial bank when there are no such entries in the real world. And I can’t imagine this fiction being retained post-vertical integration. If you are proceeding in steps in attempt to align with Steve pre-vertical integration, then I suppose I can understand. But again, where’s it all going, given it’s disconnect from how things actually work?

I don’t mean to criticize (but I suppose I am) – just pointing something out that I think you’ll have to consider at some point. Ignore it if you like.

BTW, it’s been a long time since I looked at Steve’s stuff. But seeing what you’ve done here, and where you might like to go, my instinct for what it’s worth would be to just get rid of this vault language and concept. I think it’s going to end up being problematic if you do go to a full vertical/horizontal model. Just a thought.

Apart from that, looks like a lot of excellent work as a step forward.

Martin Lowy said...

The double entry B/S approach shows very well what is going on. I appreciate that. But I have a question that is thrown off by the necessity to add the goodwill at the beginning:

No banking license is needed in order to make loans. Under most state laws, loans can be made by any entity (although the banking lobbies have limited some exemptions from usury laws and other consumer protection laws to banks, making it difficult for non-banks to make some kinds of loans profitably). The license that banks get is the license to accept (create) deposits. Thus, only a bank can create both the deposit and the loan.

Any other type of entity would have to borrow the money to make the loan, and that borrowing would have to go through the banking system. But the eventual impact is not very different, since the bank will have to borrow the money from somewhere when the borrower spends the deposit balance.

The non-bank lender is constrained by the market's capital requirements--therefore no regulatory capital requirements are needed. The bank needs regulatory capital requirements because it has deposit insurance and access to the Fed. The regulatory capital requirements are far lower than the requirements that the market would impose absent the federal subsidies. Thus the bank's real initial goodwill comes mostly from the federal subsidies that alter the market's perception of the capital needed to support the bank's business. That subsidy applies to the bank's entire balance sheet--allowing it to be larger than the market would permit--but it does not apply only to loans, and the bank will make loans only if doing so is more profitable than other businesses.

Neil Wilson said...

Martin,

It's not goodwill. It's credit potential and it is a device in the model to make the total credit potential of this economy explicit for those who are studying its effects.

The model is a model of an economy - an aggregate of all banks, all firms, and all workers.

Trying to tie this model down to the particular devices by which an individual bank is regulated in a particular country is not straightforward.

It is far too easy to misinterpret the words and misunderstand the functions.

For example if you, as a business, take trade credit with a supplier then they have a deposit with you and you have a liability to them.

Martin Lowy said...

But how do you avoid putting the rabbit into the hat? That is, how do you measure the credit potential, since it is a crucial first principle?

Neil Wilson said...

credit potential is dynamic based on the limiting rules in play in the particular economy.

It could be a fixed amount, or a complicated equation

Evolving the model in that direction is how we check it is accurate (modelling the credit restrictions in various countries and ensuring the output looks something like), and then test new ways of limiting banks credit lending capacity.

Anders said...

Neil - can you express what is beneficial about this 'Keenian synthesis' approach, relative to Godley's pieces, eg the transaction matrix below?

http://www.ipc-undp.org/publications/srp/TOWARDS%20A%20RECONSTRUCTION%20OF%20MACROECONOMICS.pdf

Clonal said...

Neil,

Work with Fred Decker at Modern Monetary Theory

He is trying to integrate Keen, Yamaguchi, Godley & Lavoie along with adding economic "classes" into the simulation model. His model has three worker classes, the top 1%, the bottom 20%, and the remaining middle.

You might find his framework useful as well.

Neil Wilson said...

The more viewpoints from which we look at this particular problem the better model we shall have from the convergence of them all.

Many hands make light work.

Magpie said...

Very impressive. Congratulations, Neil

paul said...

anders,

keen answers your question here

http://www.debunkingeconomics.com/Papers/Money/KeenModellingEndogenousMoneyICAPE.pdf

Anders said...

Thanks Paul. I had just discounted this piece by Keen on the grounds he didn't understand accounting. Much as the continuous vs discrete time has its attractions, the lack of read-across to how data on actuals is prepared (eg UK's ONS data which is entirely stock-flow comprehensive) seems a major flaw.

AUD said...

If your objective is to model the economy I wouldn't focus on banks or deposits/debt/money. The correlation between debt and production is yes more than not they move together but it is not as tight as some other things you can choose and the focus on finance in our world seems to indicate.

However if you want to start with finance you could start by building a model of economic entities with a sub class of attributes associated with their ability to interface with the payments systems [and I mean plural], and then another sub class of attributes associated with trade-able items of those economic units and "match latches" of those trade-able items of other economic units.

That is, I am agreeing more or less with Martin Lowey 11 January 2012 13:33 but probably even moving more from seeing "Bank" as having a unique place in the system [though having access to particular central payments systems flags set].

A "deposit" is of course a capacity to be accepted as legal tender in a payment system. That's it. Full-stop.

That takes you to the extent to which that payment system will honor the order.

"Trade-able items" are the things you hand over to the other party for the number increase in your deposit account.

"Match Latches" are the demand for trade-able items, and obviously have as a class consideration of Barter.

Consider this: If two banks raise loans and their customers settle customers of the opposite banks for purchases, and the amounts are equal and a huge $1 trillion dollars, does each bank have to hit the payment systems of the jurisdiction with any transfer?

If not then what is the limit? [And there are limits].

Thoughts?

Andy said...

Neil
I think this is a real step forward in an accounting or presentation sense anyway.

I don't know about Steve's model but this lays out beautifully on a spreadsheet if you use strict double entry rules (the way we learned it in the old days) i.e. To increase an asset debit or + the account..
To increase and expense ... blah blah.. and you set Bankers, Firms and Workers each with their own columns for Assets, Liabilities, Income, Expense and Equity side by side and then you record the full double entry for each of them for each type of transaction.
Consumption can be treated as an expense or an asset (same rules) but when you 'prepare your accounts' you would clear them to Equity along with Income & Expense

I'm going to have fun messing about with this.

I think your 'licence' is going to be NFA's b/f and Govt transactions will work just as beautifully.

Thanks

Peter Shaw said...

Steve Keen and Neil Wilson have achieved a "Godley/MMT convergence", using mathematical economic and accountancy principles. I propose a second convergence with a prototype model I developed from a very different perspective. NW's elaboration (as his credit_licence_phillips diagram) is a version of my own, enabling me to make the connexion. For this reason, his work is far from "a bit of a sideshow", as the one tends to validate the other.
Some ask "Where's this going?". I have reason to suggest: To a rational model of the economy, containing insights towards its better management. Don't laugh until you see where this leads.
My model allows me to identify an ambiguity in NW's diagram as-is. Streams A,E,& F all should link to the "Firms" storage.

Assuming this, the broad pattern is:
> An apparently isolated loan/repayment circulation (my Capital loop);
> Two semi-independent Consume circulations (my Spending loops), joined only at the "Firms" storage. Any additional Spending loops must conform to this pattern.
> The upper loop involves the Financial role, and the lower the Commercial one. Real-world organisations may combine aspects of these.

We need consensus on this before adding two more features needed for complete economy modelling and the "substantive debates".

Note that SW's (and my) model is at root an aggregate one, so should not be applied to a single enterprise. What it does provide is the exact economic environment an enterprise operates within.

Chemical process icons are entirely appropriate for this purpose, and will help engineers to contribute. Alternatively, their electronic circuit equivalents should attract process-control theorists. These would note that two lags in a feedback loop (as here) may cause instability...

Peter Shaw said...

From the model values:
> Unit capital flow enables 17 units of after-tax spending
> Unit commercial spending is supported on only 1½% of financial spending, or conversely 66x.
These two factors are arguably important metrics of an economy, but seem not widely discussed (I have as yet found no names for them). Are real economies as capable as these suggest?

Peter Shaw said...

An Open Letter to Professor Keen
Sir-
I long ago decided that I didn't understand economics. Your book "Debunking Economics" goes far in explaining why.
In it you describe the persistence of neoclassical economics in ignoring information from "outside" - here, yourself and your ilk. You present the root
problem as not technical, but one of communication. I do not wish you to risk a similar error.
You argue that the economy is generally unstable, so any assumption of equilibrium should be discarded; also that control of private debt prevents crises. From a different direction, I have reason to support the latter as necessary, but think proper management of private debt may be a sufficient condition for equilibrium. This issue is clearly strategically vital to resolve.
I suspect you are in the position of one of the fabled three blind men who encountered an elephant, and that I may be another.
You promote the 'gut feel' of economists (student or other); I suggest generalising this, as we have been operating an economy for millenia, and the general public likely has a 'gut feel' for what is economically sound, and what not. Some of these may be frequent visitors to your blog, as I am. I note you see need to communicate with a wider audience than traditional.
If you think this post overdone: my experience is that lesser efforts fail.
Is the internet (and your blog in particular) the proper forum for developing such economic ideas? If so, I propose initial objectives of:
> Proving my prototype model;
> Assimilating it to your model via Neil Wilson's arrangement of it;
> Defining constraints allowing a steady-state;
> Agreeing proper metrics for the new model.

The proposal of giving away money (or loaning to ‘prodigals and projectors’?) is bizarre enough to tell me that a better crisis solution exists.

Of course, I may have the wrong elephant. It's a risk.

Respectfully

[I post this on Neil Wilson's blog as you co-operate closely with him, and you have raised a barrier to contributions to your blog. I cannot resist noting this supply-and-demand example, and its implication that information is a normal commodity.]

andrewlainton said...

Ive extended this model with a detailed treatment of bank capital - would be greatful for your views

andrew bailey said...

Can I suggest that the double entry for the initial recording of the intangible asset “Grant licence” should be debit the asset “Licence value”, credit capital reserves (Equity). You have recorded the credit entry under liabilities, which it clearly is not.
I’m struggling with you double entry. Take “Lend money”, the double entry extends over two separate entities, the bank and the firm. Therefore, there is single entry bookkeeping in each entity. Take “Record loan”, debit the asset (loan ledger, ok), but credit the “Lending power value” ? A bank lending money will see a reduction in its cash, not its lending value.

Neil Wilson said...

It is if that's how you want to model it - which I do for the purpose of this model.

The fundamental equation is Assets+Liabilities=0. Equity is just a form of liabilities.

The layout of structures in this model was to show equivalence with Steve's original model.

A bank lending money does not see a reduction in its cash. It sees a reduction in its power to lend. Banks don't lend cash. Cash is utterly irrelevant to lending.

You can advance a loan, which will reduce its lending power, without it necessarily being drawn down, which means the actual matching liabilities remain in the vault.

andrew bailey said...

Ok, but you have not addressed one of my points: your double entry extends across independent entities, the bank and the firm. For “lend money” and “record money”, you end up with 2 debits and 1 credit in the bank !
If banks don’t lend cash (money), then what do they lend ?
Loan advance and drawdown are the same. The actual drawdown of the loan triggers the accounting entries; you cannot double entry account for loan agreements.
I don’t wish to be pedantic, but I will be if only to protect the integrity of accounting terminology.
1. Equity and revaluation reserves (Licence value) are not liabilities. A liability is a legal obligation to repay a debt, there is no legal obligation for a company to payback share capital or reserves to its shareholders.
2. You state “That makes this table inconsistent with the fundamentals of double entry that requires every transaction to sum to zero” . The fundamentals of double entry bookkeeping are that the total of the debits = the total the credits, a subtle difference and more commonly understood. The reference to “sum to zero”, is just a control function on your spread sheet.
3. You state that “The fundamental equation is Assets+ Liabilities=0. “ I think you meant to write Assets (minus) Liabilities = O.
An appendix of definitions/terminologies would make things clearer to the reader

Neil Wilson said...

The model is only the model of the world from the bank's point of view. So the transactions are all in the bank!

That is consistent with Steve's original approach.

You can double entry for loan agreements. That's what I have done by making the loan capacity explicit on the balance sheet. A loan agreement is a reduction in the capacity to loan and in increase in Loans.

Equity and revaluation reserves *are* liabilities in the broader sense of the definition of a liability - as in a negative asset. That is then broken down into those that need regular service and those that don't which is where the normal understanding comes from.

Your point are now descending into the pedantic and the 'I want to be right' school of argument. I have pointed out why I have done things as I have done - which was to achieve the goal of rectifying Steve's model to be consistent with double entry but still be identifiable as the original model

That is the approach I've taken here and it has achieved the purpose I wanted it to achieve.

Accounting is always an opinion, and the presentation is always tailored to the requirements of the target audience.

That is the reason it is as it is here. There are many other presentation viewpoints that could be constructed from the same basic data and they would all be correct as well.