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Economics21st's avatar

When I first read about bookkeeping as a teenager, one of the things which confused me was the insistence that debits must equal credits for a given transaction. E.g. if a firm buys a delivery van for $20,000, it credits the "cash" account by $20,000 and debits the "vans" account by $20,000. But what if it had been offered a 10% discount? Its "vans" account would have an $18,000 debit. Are the vans somehow worth less because the firm didn't have to pay as much for them?

Now I understand that some of accounting, particularly valuation, is accounting convention, which is corrected over time (e.g. by depreciation, or sale of the van). For economic modelling, I've started using the idea of "raw net worth": not assigning monetary values to everything. So when a firm buys a van for $20,000, it loses a $20,000 asset and gains a van asset. It's not appropriate for accountancy, which must assign a fair value to a firm, but it's a much more direct model of what is actually happening, making it work very well for economic modelling.

I also split transactions into individual actions (each represented by a coloured arrow). So buying a van is 2 actions: (1) transfer of $20,000 from the firm to the seller, which decreases the firm's raw net worth by $20,000, and (2) transfer of the van from the seller to the firm, which increases the firm's raw net worth by the van.

(If you're in the mood for a slight complication, there are actually 2 more actions: (3) decrease in firm's equity by $20,000, and (4) increase in firm's equity by the van).

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Marco Learns Macro's avatar

learning alot here. thank you! was led here from economcis21st substack.

and the juxtaposition of both your frameworks helps clarify many things. Much appreciated!

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