Chapter 15: Q3. (page 318)
What is the difference between an asset and a liability on a bank’s balance sheet? How does net worth relate to each? Why must a balance sheet always balance? What are the major assets and claims on a commercial bank’s balance sheet?
Short Answer
Expert verified
An asset is something of value that is owned by the bank and can be used to produce something, while a liability is a debt or something the bank owes.
Net worth is the difference between asset value and liability.
The balance sheet always balances because of the double-entry method of accounting practiced, and assets always equal liabilities plus net worth.
Cash in hand, reserves, and property owned are major assets, and outstanding stock and checkable deposits are major claims on a commercial bank’s balance sheet.
Step by step solution
01
Difference between asset and liability
An asset is something of value that is owned. For example, the bank has a cash reserve of $10,000. The cash held by the bank is its asset. If the bank has its own building from where it operates, the building is a new property asset to the bank.
Liability is what you owe, a debt that needs to be paid. For example, the bank sold $75,000 worth of its shares to the public as stock, which becomes the liability, which the bank owes to the public.
02
Relation of net worth with asset and liability
Net worth is the difference between the assets and liability a bank owns. The formula is:
Net Worth = Assets – Liabilities
For example, the bank holds a cash reserve of $250,000 and owes $75,000 as stock to the public. Accordingly, the net worth of the bank will be:
Net worth of the bank = $250,000 - $75,000
= $175,000
03
Reason why the balance sheet must always balance
A balance sheet is balanced because Assets = Liabilities + net worth
Every $1 change in assets must be offset by a $1 change in liabilities + net worth. A $1 change in assets must offset every $1 change in liabilities + net worth.
04
Major assets and claims on a commercial bank’s balance sheet
Assets help banks gain profits and earn from them. The major assets are cash in hand, reserves, and property owned by the bank.
Claims are liabilities that have to be given up and paid. The claims are outstanding stock, checkable deposits.
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