A User Guide to the Canadian System of National Accounts

Note to readers

This document is a guide to the various components of the Canadian System of National Economic Accounts, describing frameworks, major concepts, definitions and the purpose of each component. It was published in 1989. Most of the information does not change. However, the Canadian System of National Economic Accounts is constantly making important improvements. For more information see Latest developments in the Canadian economic accounts.

Chapter 5

Financial Flows and Balance Sheets

II - Balance sheets

General

The national balance sheet accounts published in 1985 represent the most recent development in the Canadian System of National Accounts, and in fact, complete the economic system of accounts as they are presently conceived. The latest set of accounts expands on those available in previous years. In early 1976 partial balance sheets for the years 1970-1972, covering only financial assets and liabilities for selected sectors, were published.

In the following year these were revised and extended to cover the full range of years for which the financial flows were available, 1961-1976; they were subsequently updated and revised on a regular annual basis.

The major development in the currently published series is that they now include estimates of the stock of nonfinancial assets and an estimate of net worth, instead of being restricted to financial assets and liabilities. The balance sheets cover all sectors and sub-sectors represented in the financial flow accounts, as well as a summary of the four main national accounts sectors. The schematic presentation shows the balance sheet in matrix form for the four principal sectors. The sector balance sheets are statements of what each sector owns, what it owes and its net worth at a point in time.

Even though the full range of tangible and intangible nonfinancial assets is not included in the estimates, the present structure allows the calculation of a restricted figure of the wealth of the country. The national wealth is defined as the total stock of non-financial assets in the country; a net national wealth concept adjusts this figure by the country's net international indebtedness - its financial claims on, less its liabilities to, non-residents.

In contrast to other branches of the national accounts system which measure flows between two points in time, the balance sheet measures the stock of assets and liabilities and net worth at a point in time. It is a snapshot of the condition of the nation as opposed to a record of movement.

Despite this different perspective, the national balance sheet is as closely related to the other components of the system as a firm's balance sheet is to its statements of income, retained earnings and changes in financial position. Changes occur in the stock of assets and liabilities in large part because of saving and investment and lending and borrowing decisions. To the extent that a firm retains earnings and purchases new fixed capital during a period of account, the balance sheet will change.

To the extent that a nation curbs its consumption, saves and invests in tangible assets, so will its balance sheet record increased non-financial assets and national wealth.

Within the context of the System of National Accounts the development of balance sheets has been regarded as vital by some economists. It is considered a key component of the analytical apparatus, without which changes in economic variables, particularly those depicting the financing of economic activity, cannot be adequately understood and explained. Institutions, it is claimed, are guided in their investment policies by the existing distribution and level of financial claims and by balance sheet ratios, such as those indicating liquidity. Estimates of the stock of fixed capital have long been recognized as a crucial ingredient in the analysis of productive capacity and as a critical factor in assessing potential investment programmes and demand for new funds.

The Canadian system presents the balance sheets both in the form of time series for single sectors and in the form of single year matrices covering twelve domestic sectors and the rest of the world sector. The matrix includes the detail of non-financial and financial assets, liabilities and net worth in a single column for each sector, the net worth being the excess of total assets over liabilities. The sector columns also include a sub-total for net financial assets. A positive figure indicates outstanding net financial claims on other sectors and a negative figure, the net indebtedness of the sector to others.

Under present national accounting conventions, investment in non-financial assets in Canada by non-residents is not classified as such. In the financial flows and national balance sheets, investment in fixed capital by non-residents is recorded as if undertaken by a notional domestic unit with financing provided by an external unit. A domestic sector is shown to have increased investment in fixed assets and a counterpart liability, while the financial investment of the rest of the world is shown to have increased by an equal amount.

A condensed example of the single year matrix is given below.

Annual Matrix

	Sectors 1 ... to ... 13	Total All Sectors	National Balance Sheet	Consolidated National Balance Sheet
Non-financial Assets ...
Financial Assets ...
Liabilities ..
Net worth ...

The rows in the matrix are summed in three ways:

1. the first, labelled 'total', is a simple addition across all sectors, including the rest of the world, in which financial assets and liabilities completely balance,
2. the second total, labelled 'national balance sheet', adds across all domestic sectors, omitting the rest of the world. The financial assets and liabilities in this column no longer balance due to Canadian net indebtedness to the rest of the world; the total net worth of all domestic sectors falls short of the country's non-financial assets to the extent that part of investment in Canada has been financed by the rest of the world,
3. the final column, 'consolidated national balance sheet', nets domestic liabilities against domestic financial assets, the residual balance representing Canada's net indebtedness to the rest of the world.
   Net worth at the national level, otherwise known as net national wealth, is equivalent to total non-financial assets less Canada's net indebtedness to the rest of the world. This form of presentation is frequently referred to as the national wealth statement.

Table 4A and Table 4B, in addition to giving 1981 figures for the financial flows, also provides a condensed version of the balance sheet matrix as at the end of the year.

Extending the statistical analysis of the economy

Building from the framework developed for the financial flow accounts, the national balance sheet accounts do not expand the sector detail, nor to any great extent do they extend the classification of categories of non-financial and financial assets and liabilities, but they do provide a picture of the economy in a completely new dimension.

The new range of data are consistent and integrated with other components of the System of National Accounts through a series of reconciliation statements. The balance sheets contribute to the extension of knowledge in a number of ways. They reflect both the effects of capital transactions from the income and expenditure accounts, and lending or borrowing activity from the financial flow accounts; they also permit an assessment of the impact of revaluations of assets on national wealth and an individual sector's net worth.

The balance sheet accounts build to an important national figure, the net wealth of the country, or as it is sometimes called the national net worth. Net worth is the value of all assets less any liabilities. The definition calls for the resolution of a number of issues including decisions on the scope of the assets to be included in national wealth, the most appropriate valuation of items, and the maintenance of consistency with other components of the national accounts; The size of the national wealth estimate hinges on what tangible and intangible non-financial assets are included.

The Canadian accounts include first and foremost, the stock of tangible reproducible capital - items of fixed capital such as residential and non-residential construction, machinery and equipment, and inventories of raw materials, goods-in-process and finished goods.

This grouping includes land improvement costs and transfer costs on tangible non-reproducible capital. The inclusion of these goods is consistent with the capital formation estimates in other parts of the system.

Although more controversial, consumer durable goods such as automobiles, refrigerators, washing machines, etc., conceptually fall within the scope of the definition. In the income and expenditure accounts, these items are treated as consumption goods with no measured future stream of benefits. On these grounds it has been suggested that they be omitted from the balance sheet accounts. However, the Canadian system includes them because they do in practice yield services to households over periods well in excess of a year and, on most counts, are recognized as part of the wealth of the country.

Conceptually the wealth estimate should also include the value of such assets as land, waterways, timber resources, sub-soil deposits and fishery stocks. It has been suggested that historical national monuments should also be included under this category. Because of enormous valuation difficulties and in order to maintain some consistency with the transactions accounts in the rest of the system, only those assets which are used to produce goods and services commercially and are likely to be traded are included. The inclusion of some natural wealth estimates would raise interesting ownership and sectoring questions. Of the above list, the Canadian balance sheet accounts cover only privately owned residential and agricultural land and commercial nonresidential land.

A final potential constituent of national wealth, intangible non-financial assets, is generally defined to be composed of such items as patents, copyrights, trade-marks, leases in respect of land and buildings, and concessions to exploit natural resources. Less conventional has been the argument to include the stock of scientific knowledge and the supply of human capital as part of a nation's wealth. At present the Canadian balance sheets contain no estimates for intangible non-financial assets.

Clearly, at both the Canadian and international level there is an element of arbitrariness surrounding national wealth estimates that depends on acceptance or rejection of definitions of what constitutes capital. This is accentuated by practical problems of obtaining statistical coverage and of valuing the recommended inclusions.

As indicated earlier, for the nation as a whole, the measure of its net wealth is derived by summing nonfinancial assets across all domestic sectors and adjusting for net financial claims on non-residents, or by adding the net worth of each sector. For a single sector however, its net worth may be more or less than the value of its nonfinancial assets depending on whether it has a net positive or negative balance in its holdings of financial assets.

As with national wealth, the measure of a sector's net worth depends on conventionally accepted definitions concerning the coverage and valuation of items contained in the balance sheet. In addition, the measure is arbitrary to the extent that it may be varied depending on the purpose for which it is designed. For example, in the Canadian accounts, three estimates of net worth appear for the corporate sectors of the economy. These will be described in the section discussing the classification of assets and liabilities.

There are different perceptions of what constitutes net worth. It has been argued that no independent net worth should be attributed to the corporate sector as the ultimate ownership is traceable to individuals. Using this argument, net worth of corporations would be transformed into a corporate liability with the claim held by individuals, thus raising the tatters' asset holdings and increasing their net worth. The preferred treatment hinges on the potential use of the data. In this particular example it is doubtful whether increasing the net worth of persons and eliminating that of businesses would increase the analytical usefulness of the estimates, for this is not the perception that normally governs the behaviour of either businesses or persons.

Others have argued that a useful alternative measure of corporate net worth is one that excludes the value of issued capital stock but leaves intact the retained earnings of the corporation. The impact of financing a new project by floating a new stock issue or using retained earnings is different in many respects and is a useful distinction in the statistics.

The relationship of economic and business accounting

National balance sheet accounts are the most closely related to business accounting of any branch of the Canadian System of National Accounts. The basic identity that the value of assets equals the value of liabilities plus owners' equity or net worth holds true for the firm and the nation. The similarities are more apparent in individual sector balance sheets than at the total level where financial asset and liability claims are equal and offsetting. The major departures from business accounting occur in the areas of valuation and in specific inclusions and exclusions of items.

Assets are resources available to the firm, through ownership or the right to use, to be utilised in producing goods and services or to be sold or consumed. They consist of holdings of financial assets including amounts prepaid for such items as rent, interest and insurance that will be consumed in the next period of account. They also include non-financial items such as property, plant and equipment, inventories, and intangible assets such as patents, trade-marks, franchises and goodwill. In business accounting fixed assets are normally valued at historical or acquisition cost and are shown net of depreciation, also based on historical cost. In the national accounts the generally preferred valuation is current market value, although in practice variants similar in concept, such as written down replacement cost, may have to be used.

Liabilities and net worth are the claims of creditors against the firm including trade accounts payable, taxes and interest payable, and loans, notes and bonds outstanding, plus the owners' equity in the firm which is normally comprised of two major elements, contributed capital by the owners and retained earnings. The single most important adjustment in converting this side of the balance sheet to the economic accounting framework concerns the allocation of share capital. In business accounts the original price of stock at the time of issue is considered part of net worth, whereas in the economic accounts it is recorded as a liability under the 'shares' category in the corporate sectors.

Because the Canadian system provides estimates of net worth on three different conceptual bases for the corporate sectors some further explanation is warranted at this point. Although only one calculation is used to derive net worth on a consistent basis for each sector throughout the matrix, two additional concepts are published for analytical use for each of the corporate sectors in the individual sector presentations.

The net worth concept used for the corporate sector in the basic balance sheet matrix is derived by deducting liabilities from total assets. The owners' equity in terms of original share costs plus retained earnings is treated as a liability. In business accounts this would result in a net worth of zero or close to zero. In the economic accounts however, because fixed assets have been revalued at replacement cost, the technique results in a net worth which reflects the difference between the replacement and historical cost. The effect of treating corporate owners' equity as a liability is that it transfers most of the net worth to the sector holding the shares but leaves the revaluation of assets as the net worth of the corporate sector. This measure of net worth has limited analytical significance but fits within the balancing constraints of the matrix.

Two other estimates of net worth for the corporate sectors are provided for analytical purposes. One, which does not treat share capital and retained earnings as liabilities but rather as part of the net worth, provides a net worth figure considerably higher and corresponds to a 'liquidation' value of the sector. The other measure relates more closely to the estimate produced by standard business accounting, providing a net worth figure equal to the owners' equity with shares valued at book value plus retained earnings. This version implicitly values investment in fixed assets at historical or acquisition cost.

Continuing the comparison between economic and business accounting reveals a further difference. Business balance sheet contingency entries, such as provision for bad and doubtful debts, that have no counterpart entries on the books of another transactor are regarded as inappropriate for inclusion in sector or national balance sheets.

A number of non-financial intangible assets found on the balance sheets of business are excluded from the sector and national balance sheets, either on the grounds that they reflect in part an element of human capital or on the rather more pragmatic grounds that the collection of data is at present impracticable. These include, among others, trade-marks, patents, copyrights and franchises.

Goodwill is an example of a particularly nebulous intangible that appears on many business balance sheets. Goodwill normally results from one company's acquisition of another and represents the amount by which the purchase price exceeds the current market value of the acquired assets and liabilities. It is attributable to factors like customer loyalty, good employer/employee relationship, and exceptional ability of management.

Goodwill is not included in national or sector balance sheets on the grounds that it is largely related to the performance of human capital and is therefore not appropriate.

Valuation of assets and liabilities

i) General

Unlike those components of the system measuring flows over relatively short time periods, balance sheets present figures for assets and liabilities which have accumulated over long time periods. This poses vexing problems concerning the appropriate valuation. Data for most flow series automatically carry values relating to the current period of account, with one or two exceptions such as inventories. This is not true of balance sheets where values reflect prices and costs spread over many years.

Aggregations of historical costs have no uniformity. There are two basic ways in which balance sheets may be valued. The first, commonly used in business accounting, records data at acquisition cost and is frequently referred to as book value. The second employs current market values or some conceptually similar variant. The former method presents fewer problems of data collection and requires considerably less adjustment of data than the latter.

However, several factors must be considered before deciding upon an appropriate valuation, the most important of which are the usefulness of the end result for analyzing wealth, financial decision making and economic behaviour. The ability to obtain data in the required form and the compatibility of valuations throughout the system of accounts are also important.

ii) Current values or book values

Consideration of the above factors has generally led to a preference for current values rather than book values or acquisition costs. There is substantial agreement that current valuation has more meaning than values which may reflect prices spread over the past twenty or thirty years, perhaps even longer in the case of particularly durable assets. Aggregates based on historical costs or book values are neither comparable over time nor between firms or sectors.

In defense of book values it has been stated that they are, in fact, used by most reporting units as their valuation basis and therefore are more easily collectible. More than that however, they do have some influence on firms' decisions concerning rates of return, tax liabilities and, in the case of certain utilities, on rate regulation. In addition, analytical financial ratios frequently employ published net earnings which in general still reflect book values.

However, current or market valuation has the advantage of being consistent, comparable between sectors, readily understandable and relatable to current income flows. In economic terms the relative market valuations of capital goods reflect the market's assessment of relative present values of future net income streams. Its implementation does, however, present some formidable challenges.

The generally accepted definition of market price is that which reflects a transaction between buyer and seller in which the two parties are dealing at arm's length and on a commercial basis. It is also implicit in the definition that the market is an orderly one and not one which is overloaded with buyers or sellers.

This definition presents a hurdle insofar as many assets and liabilities to be revalued are not traded in markets where prices are frequently being set; for many there may be few, if any, transactions in the course of a year. Markets for many capital goods are severely restricted and in these cases it is necessary to resort to alternative measures to derive current valuations that are conceptually similar to market values.

The ideal situation is that in which quantity and price data exist on a current basis and quantities can be revalued each year using the appropriate current price. The best example of this exists in the stock market where large quantities are publicly traded, specific prices are quoted on a daily basis and buying and selling activity flourishes. A number of financial markets exhibit these characteristics and in such cases the current quantity times price method can be applied. Even in these near-perfect markets there are problems associated with the share valuation of non-traded and privately held companies.

iii) Reproducible fixed assets

The current valuation of reproducible fixed assets - housing, plant and machinery - requires a different technique as market prices of second hand capital goods are not normally readily available. The most common method of arriving at a current value, such as the written-down replacement cost used in the Canadian accounts, is through the perpetual inventory method. The method requires the accumulation of estimates of fixed capital investment, by type of asset and year of acquisition, over a period sufficiently long that all assets presently in the stock are covered.

Any capital assets acquired before the date from which the accumulation of fixed capital investment estimates commenced should have been retired. The stock of capital estimated as above is revalued each year, from its date of acquisition to the year under consideration, through the use of price indices.

The application of suitable price indices to different types of assets produces an estimate of current gross replacement cost. The objective is to measure the cost of reproducing existing capital in terms of its physical characteristics and not the current cost of new fixed assets capable of producing an equivalent output. An allowance for the depreciation of assets based on their assumed useful life, also adjusted to current values, must be deducted to arrive at the desired net replacement cost of the stock of capital for each year. The estimate on an on-going basis is maintained by adding annual new capital formation, retiring used-up capital, revaluing past stock and deducting the current value of depreciation.

Matching price indices to capital goods presents considerable problems. Many items of capital are unique and most others are constantly in the process of being improved so that prices often reflect quality change rather than pure price. Nevertheless, the perpetual inventory method is the one employed in producing the data used in the Canadian national balance sheet accounts. Although other methods have been, or are in the process of being developed, these have so far not been employed. The best known alternatives are those based on current appraisals of property and equipment. Estimates have been prepared from both direct surveys of owners of fixed capital and indirectly from valuations by professional appraisers for insurance or tax purposes.

iv) Inventories

Two methods are employed in the Canadian accounts for valuing inventory change. Values for the change in farm inventories are obtained by multiplying numbers or quantities of livestock and crops by market prices or unit values. The process of valuing non-farm inventories is complicated and follows the procedures used in the income and expenditure accounts to convert changes in book values to value of physical change.

v) Consumer durables

The technique for deriving stock values of consumer durables parallels that for reproducible fixed assets. The perpetual inventory method utilizes aggregations of annual consumer spending on durables by type, estimates of useful service lives, depreciation patterns and prices. By combining these variables in the same way as in the fixed asset category, an estimate of the net stock of consumer durables can be deduced. A periodic check on the results obtained from the perpetual inventory method may be carried out when surveys of household ownership of consumer durables are undertaken. Market price data are relatively plentiful for consumer durables.

vi) Renewable resources, depletable stocks and land

As the Canadian balance sheets include neither estimates for renewable resources, such as timber stands, nor depletable stocks, such as minerals and other sub-soil assets, the question of valuation has not had to be faced. It has been suggested that where such estimates are attempted, valuation be based on discounted anticipated future net earnings of the income producing assets. The procedure is complex and involves estimating production, costs, selling prices and the selection of an appropriate discount rate to convert projected income to present values.

The valuation of land, the final major non-financial asset, poses some difficult problems. First, there is frequently considerable difficulty in separating the value of land from that of the buildings erected on it; secondly, there are vast tracts of land for which there are no prices because no market exists - such is the case for much public land.

The recommended method for land on which no buildings exist is to apply current prices to quantities, assuming an active market and available current prices. Where land underlies buildings, valuation appraisals may be used to establish site to structure valuation ratios, which in turn can be used to estimate land values. If the appraisals are for years prior to the current period they should be updated to current prices. Appraisal values may have to be estimated for land that is infrequently or never offered for sale.

In general, quantity figures for land are available and it is the price data that requires an innovative approach. In the Canadian accounts, estimates are prepared only for agricultural, residential and commercial land; the value of all other land, including publicly owned land, is omitted. The method used to determine the underlying land value of residential and commercial properties employs site to structure ratios in conjunction with current values of the stock of residential and commercial properties. In the case of commercial property, including land owned by corporations, unincorporated businesses, non-profit institutions as well as some government land, the site to structure ratios are based on book values and their coverage is incomplete.

The general application of these book value based ratios provides, at best, a rather weak estimate that has been labelled as provisional in the Canadian national balance sheet accounts. The value of all privately owned agricultural land is based on census values of farms from which the net value of buildings is deducted. The separation of land and buildings is somewhat artificial given the interdependency of both components in creating a market value.

vii) Financial claims

The principle of current valuation is again generally recommended for financial claims. The application of the principle has different implications depending on the type of instrument. In the case of short-term instruments realizable at nominal or face value on demand or at short notice, book values and current market values are unlikely to diverge. For long-term claims, particularly bonds and corporate securities, market values are desirable for the sake of consistency as there may be significant differences between different holders' book values for the same instrument.

In practice, the Canadian accounts generally use book values for financial instruments; attempts to overcome the conceptual and practical problems associated with revaluing the bulk of long-term financial claims present major statistical difficulties.

Theoretically the market price of regularly traded long-term bonds could be applied to the quantity outstanding, and, where bonds are not regularly traded and current transaction prices are not available, estimates could be made on the basis of quoted prices for bonds with similar market characteristics. Corporate shares could also be valued, in many instances, on the basis of quotations in highly organized markets, but there still remain those not listed on the exchanges. On balance it was felt that book values were a more satisfactory starting point in this segment of the balance sheet accounts, although some adjustments are made to the value of shares to bring them closer to current values.

The valuation of shares is unique to the system. Shares held as assets by reporting sectors (the personal sector is non-reporting) are valued in the Canadian accounts at cost at time of acquisition but when valued as liabilities the retained earnings and reserves are also included so as to better approximate market values. The impact of this is to place the residually derived asset share holdings of the personal sector on a close to market value basis.

A special situation exists in the Canadian accounts concerning the equity investment of a parent corporation in an associated company. The parent's ownership of capital stock in its associate is classified to a special asset category 'corporate claims', whereas the stock issued by the associate to the parent is classified as a share liability. This treatment is dictated by business accounting records and the fact that the extent of the parent's holdings of shares in its affiliate cannot be determined from accounting records alone. The equality of individual category assets and liabilities which holds true in the matrix for all other categories does not hold for the 'corporate claims' and 'shares'; assets and liabilities for these two categories are only equal when summed.

The Canadian system requires that each financial asset and liability, category be equal, with the exception noted above. In the case of discrepancies due to problems of coverage or valuation, data are scrutinised to determine the most likely cause, after which the discrepancy is allocated to what is believed to be the appropriate sector. The procedure is not dissimilar to that which occurs in the input-output system in balancing the supply and disposition of commodities and it depends heavily on the knowledge and ability of the compiling statisticians.

Although only touching on the main topics concerning valuation of the nation's wealth, this section has indicated some of the difficulties. The question of valuation ranks highly amongst those affecting the measure of wealth since the final estimate is significantly affected by decisions regarding valuation choices. The Canadian balance sheet accounts, along with those of other countries, are still in the early stages of development with regard to finding satisfactory solutions to the many problems of valuation.

Sectors and asset and liability categories

The sectors and transaction categories used in the financial flows and the national balance sheet systems largely coincide. The reader who is interested in a brief description of sectors and categories constituting the balance sheet framework is referred to the earlier part of this chapter dealing with the financial flows. The following is primarily concerned with some general observations about the sectoring and the units best suited for sectoring balance sheet material, plus some comments on the categories used to classify balance sheet items.

a) Sectors and units of classification

As previously noted, no one set of sector definitions is suitable for all purposes and for all countries. The evolution of sectors in the Canadian financial accounts reflects the institutional development of the country and to some extent the availability of data. At the most aggregate level the sectors are institutional and can be linked directly with those in use in most other components of the Canadian system - persons and unincorporated business, corporate and government business enterprises, government and nonresidents.

In the financial system, the structure of sectoring goes beyond the basic criterion of grouping all units with similar patterns of behaviour and motivation into four basic sectors. At least two other criteria are applied. The first is ownership and the second is type of activity. The application of the first guideline produces a sub-sectoring of the corporate and government business enterprise sector into private and public enterprises; the second extends the subsectors into financial and non-financial, with further subdivision of financial units according to type of service provided or activity undertaken.

The greater detail increases the analytical usefulness of the balance sheet accounts but it also increases the problems of correctly allocating reporting units to single sectors when they are involved in a number of activities. It also raises issues that are largely absent when dealing with the four main institutional sectors alone, such as defining the unit to be allocated to sectors, and the degree to which combined or consolidated balance sheets are preferable. The two issues are interwoven to the extent that if the unit is, say, the enterprise, financial transactions and balance sheets will automatically contain a degree of consolidation.

The transactor units used in the different components of the System of National Accounts vary according to the data needs of the particular system and their analytical usefulness. There is a class of business unit suitable for compiling data on production and associated types of data for input-output and industrial systems and one more suitable for providing analytically useful data relating to capital and financial transactions for the income and expenditure and financial systems. The former is the 'establishment' unit and the latter, the legal corporation or the enterprise.

Three arguments in favour of using enterprise or family of corporations units for balance sheet accounts are that transactions between members of the same family which may have little economic significance are consolidated out; financial decisions tend to be made on the basis of the overall operations of an enterprise rather than on the basis of separate legal entities within the enterprise; in the case of unincorporated businesses and their owning households, considered as family units in this context, separate financial records and decisions frequently cannot be distinguished.

Two practical disadvantages have been raised against using the enterprise or family of corporations as the unit. The first is that it is not a universally recognized unit for data collection or compilation, and secondly an enterprise frequently engages in a number of different activities so that its allocation to one subsector blurs the sector boundaries.

In the Canadian accounts, sector balance sheets mainly relate to individual corporations and their totals reflect combined rather than consolidated balance sheets. This means that many financial claims between commonly controlled families of corporations are included in the results. The decision to use the legal entity as the reporting unit was based on the general availability of data, although in some instances data are available on a consolidated basis.

Sector balance sheets are also combined rather than consolidated in the sense that they reflect claims of corporations on other unrelated corporations classified to the same sector. This also applies to government units forming the various public sectors.

In the federal government sector, for example, a part of Government of Canada treasury bill and bond liabilities are recorded as asset holdings of units belonging to the same sector. Intra-governmental department claims are however consolidated out in the sector balance sheets.

b) Asset and liability categories

The definition and valuation of financial assets and liabilities have already been discussed and this section is mainly concerned with non-financial assets and certain aspects of financial claims peculiar to balance sheets. National balance sheet accounts are regarded by many users as synonymous with national wealth estimates and may largely be used in this context. To the extent that they are so used, financial claims become largely irrelevant and attention is focussed on non-financial assets.

i) Non-financial assets

The distinguishing characteristic of wealth and the source of its value is its ability to contribute to future income flows through direct or indirect production of goods and services. Canadian national wealth estimates are restricted in the above sense for practical reasons and only reproducible fixed assets, inventories and consumer durables, plus land used for agricultural, residential and commercial purposes are included. Public land, depletable and renewable natural resources, and non-financial intangibles like trade marks, patents and copyrights and human capital are omitted.

The valuation of fixed capital stock in the balance sheet accounts is net of depreciation and covers construction and machinery and equipment.

Costs associated with construction, such as architectural fees and the value of work done on site development, land development and the extraction of natural resources are considered to add to national wealth. Military equipment and buildings are not included in the wealth estimates with the exception of residential accommodation built for military personnel. The fixed capital and inventory stock series are conceptually consistent with the investment flow series that appear in the financial flow and income and expenditure accounts.

Residential capital stock includes private and public dwellings, fixed structures and mobile homes, as well as any equipment normally considered an integral part of the structure, such as air conditioning and heating systems. Ancillary buildings and structures in the nature of garages and swimming pools form part of the estimate. The net valuation is based on a gross estimate less allowances for demolished buildings and depreciation of the existing stock on the basis of a fixed annual percentage.

Non-residential capital stock includes buildings such as factories and office buildings and all types of engineering construction including roads, dams, bridges and transmission lines. The net valuation is again derived by deducting losses in value through physical deterioration and obsolescence from gross stock estimates. In the context of net capital stock estimates, the wear and tear on an asset is assumed to occur evenly over its life-span - the 'straight-line' depreciation method.

The estimation of net capital stock involves a number of points at which there may be conflicting viewpoints. There may be different views on the merits of measuring capital on a gross or net basis - the former may be more appropriate for productivity studies and may in fact be more accurate. If net capital is the preferred option there may be different opinions on the manner in which depreciation should be calculated.

Increments to fixed assets normally occur through new production, but there is an important exception for imports of second hand equipment and material. In this case, the purchase of used equipment constitutes a net addition to the stock of wealth of the country.

Domestic sales and purchases of existing fixed assets are reflected in national balance sheets only to the extent that they involve some net addition to the stock of wealth through the capitalized value of legal fees and real estate commissions involved in the transfer. Sector balance sheets do however show transfers between sectors due to these sales and purchases.

The wealth estimates include the value of inventories of raw materials, goods-in-process and finished goods. For balance sheet purposes such stocks are valued at current market prices and not at the book values more normally used in business accounting records. Wealth in the form of inventories is somewhat different from other components in the sense that it is working capital, and is physically consumed in the production process. The level of stocks are directly affected by changes in the level of production.

Fixed assets are not directly consumed in production, nor do changes in production have a residual impact on fixed assets.

National balance sheets are the only branch of the System of National Accounts to treat certain consumer goods as part of the wealth of the country. The estimate includes the net stock of consumer durable goods considered to yield a service to the consumer for a period in excess of a year. Automobiles, household appliances, furniture, carpets and other floor coverings and recreational equipment constitute the major part of the stock figures. The perpetual inventory method used to estimate fixed assets was also ,used for consumer durables including estimates of assumed service lives and 'straight-line' depreciation.

The value of land is the final component of the present wealth estimates contained in the balance sheets. The coverage is restricted to privately-owned agricultural and residential land, plus commercial land including some government land. This component of the wealth estimate, because of its developmental nature must still be regarded as provisional. As noted in the section on asset valuation, residential and commercial land stock estimates are based on ratios of land to structure values applied to the total value of structures. Values of privately owned agricultural land are derived by deducting the value of farm buildings from the total capital value of farms estimated from census data. Direct measures of quantities of land multiplied by current market prices are not available.

ii) Financial claims

National balance sheet accounts, like financial flow accounts, deliberately omit certain financial claims normally found in business accounts.

Contingent liabilities, for example, are excluded on the grounds that they are uncertain and have no counterpart entries on anyone else's books. Claims fixed in foreign currencies are converted to Canadian dollars for balance sheet purposes. The translation is carried out at the exchange rate in effect for the current period, so that although no revaluation for change in the market price of the foreign currency instrument itself is introduced, the value of the instrument reflects changes in exchange rates.

The life insurance and pensions category is one of the most important in the balance sheet and requires some words of explanation. The item appears as a personal sector asset and as a liability of the life insurance and pension funds sector. The estimate represents the net equity of households in life insurance reserves and pension funds, and its treatment in the balance sheet accounts is in accord with that afforded it in the rest of the system where the reserves held against life insurance policies and pension arrangements are regarded as wealth belonging to persons.

The estimate is restricted to claims on funded plans and no estimates are made for general government social security pension plans. It could reasonably be argued that individuals' behaviour may be equally affected by unfunded as by funded pension schemes and that net equity in the former should appear as part of the personal sector's wealth. The different treatment hinges, at least in part, on the lack of earmarked assets or an adequate measure of equity in the case of unfunded schemes.

The quality of the financial assets and liabilities estimates may be compromised because counterpart asset and liability entries will be out of balance when the issuer and holder strike their balance sheet statements at different dates.

Even if balance sheets relate to the same date, the time at which a single transaction is recorded in the books of borrowers and lenders may differ, giving rise to the well documented 'float' problem. In some situations, particularly in the personal sector, no balance sheets are ever struck by the household sector so that direct collection of data is exceedingly difficult.

Other features of the national balance sheet accounts

Apart from the basic balance sheet presentations which serve as data bases and analytical tools, a major feature of the accounts is the reconciliation table. This table provides information on the causes of changes in balance sheet levels from one year's end to the next. Because it provides the link between financial flows and balance sheet accounts it has already been described in the conclusion to part I of this chapter covering financial flows.

In addition to providing the link between flows and levels, the reconciliation account is of interest in its own right as an integrating device and analytical tool. The table shows changes between opening and closing balance sheets divided between those attributable to financial flows and those that are not. Changes not attributable to financial flows are sub-divided into a number of different categories, the most important of which is that change in the value of assets and liabilities outstanding due to price movements.

Revaluations due to price change arise for a number of reasons. The revaluation of the stock of fixed capital and consumer durables to current replacement costs each year results in substantial unrealized capital gains during periods of rising prices. The application of market values to those assets sold between opening and closing balance sheet dates automatically results in a revaluation when there is any difference between opening balance sheet valuation and market price. A third significant revaluation results from exchange rate fluctuations - the translation of securities denominated in foreign currencies into Canadian dollars at current exchange rates frequently yields significant unrealized gains or losses.

The valuation of shares in the balance sheet results in changes which differ considerably from financial flows. The difference is categorized as conceptual in the Canadian reconciliation table, although it might well be viewed as a revaluation since the addition of retained earnings to the value of issued capital stock in the balance sheet valuation of shares is a proxy measure for the market value of shares.

The significance of the revaluation estimate in the reconciliation accounts is that it provides, for the first time in the framework of the national accounts, some rough assessment of the increase or decrease in wealth attributable to price change. To the extent that the holders' economic behaviour is affected by a perception of net worth in current market prices, the annual revaluation estimate may lead to a, better understanding of production, consumption and changes in saving rates.

The reconciliation account also furnishes data on changes in sectors due to take-over activity, the resectoring of units due to privatisation, and the recording of unforseen events. In the event that the Canadian balance sheet accounts should include estimates of the value of renewable and depletable natural resources, the reconciliation account would have to record the value of net new findings of sub-soil assets and the growth and depletion of timber lands and commercial fisheries.

A positive aspect of the reconciliation account, easily overlooked, is the assistance and discipline it provides to producers of national accounts. The enforced crosschecking and documentation of procedures and events required to complete the reconciliation account undoubtedly improves the accuracy and reliability of both the flow and stock accounts.

Uses of the national balance sheet accounts

Because of the relatively recent development of the Canadian balance sheet accounts, there are as yet few practical examples of the use of the accounts. Experience in other countries, however, suggests a number of potential uses.

The present structure of the accounts constitutes a compromise between a general and specific purpose set of accounts, and between a conceptually pure and a statistically feasible framework. The accounts in the end are designed both to integrate with the other components of the Canadian system and to satisfy as broad a range of uses as possible. It can be argued that the range of uses would be expanded if greater detail were provided, for example, both historical cost and current market price valuations, but this development must await further research.

The principal analytical uses of the accounts involve studies of structure and relationships. Estimates of the total wealth of the country classified by assets and sectors provide the background for structural analysis of strengths and weaknesses of the country. For example, they permit an assessment of the stage of development of financial markets, they provide data for gauging the importance of foreign capital in the country's development, they allow international comparisons of the role of capital in the stage of development of a country and they provide the background against which future financial requirements can be projected.

One of the most common uses is that in which both the stock of capital and the production flows are studied together and capital-output ratios are established. The role and productivity of capital is one of the most important determinants of the economic well-being of a country. Combined with other factor inputs, total factor productivity measures provide a tool used in studies of efficiency or in the development of policies for increasing productivity.

More emphasis is also being placed on balance sheet analysis, not only for purposes of understanding changes in balance sheets brought about by investors' profit optimization portfolio adjustments, but because sectors' spending and saving decisions are, to some extent, the result of the relationship of their income to the composition of their balance sheet holdings.

A further widespread use of balance sheet data involves the establishment of ratios for balance sheet items, and between balance sheet items and other financial data.

Behaviour is often influenced by attempts to maintain certain ratios. For example, in the case of non-financial business units, the ratio of current assets to liabilities and stocks to sales are considered important indicators of business health. There is also considerable interest in such relationships as consumer debt outstanding to personal disposable income. Financial institutions strive to maintain certain reserve and liquidity ratios. The preparation of the national balance sheet accounts, with full coverage and consistent definitions, permits a rigorous analysis of ratios for all sectors and sub-sectors.

National balance sheet ratios that portray certain aspects of a country's financial development include the ratio of financial to tangible assets and of intermediaries' financial assets to total financial assets. Other ratios of economic interest that have been suggested are debt to asset ratios and net foreign investment to total national assets.

The provision of national balance sheet accounts, used in conjunction with other components of the System of National Accounts, should open the door to increased research and understanding of the complex relationships that exist between the real world of production and the paper world of finance.

Links and reconciliation with the international investment position

National balance sheet accounts are linked directly with the financial flow accounts, the former representing stocks generated to a large extent by the cumulation of past flows recorded in the latter. Any differences in concepts, valuations and classifications between the balance sheet and flow accounts were described in the final section of part I of this chapter.

This section focusses on one of the least known and recognized links in the System of National Accounts, that which exists between the rest of the world sector in the balance sheet accounts and the international investment position statement. Both these record levels of financial assets and liabilities, deal only with claims existing between residents and non-residents, and are balanced by a net foreign claims figure.

There are several difficulties in recognizing the link. The classification of financial instruments, or categories, is quite different and not easily reconcilable. The two systems view the accounts from different perspectives:

the rest of the world sector account in the national balance sheets views investment in Canada by nonresidents as an asset and borrowing as a liability, while the international investment position statement records non-resident investment in Canada as a liability and resident investment abroad as an asset. The international investment position is not always recognized as having the same relationship to the balance of payments as national balance sheets have to the financial flows (Canada's international investment position is based essentially on cumulations of past balance of payments net capital transactions plus net retained earnings).

Detailed reconciliation between the two systems can only be done at the worksheet level, with extensive rearranging and regrouping of assets and liabilities. The classifications and terminology employed in the international investment position statement are those used in balance of payments statements and recommended by the International Monetary Fund statistical manuals. The balance sheet classification system is quite different.

The reshuffling of primary source material to fit both systems involves grossing up some items that appear on a net basis in the international investment figures to meet balance sheet requirements, combining or sometimes sub-dividing types of financial assets and liabilities to fit different classification systems and, of course, transposing asset and liability categories.

The different classification categories for assets and liabilities in the two systems arises largely because of different analytical uses of the data. Balance sheet claims are primarily classified by type of instrument and with a range sufficiently great to encompass the claims of the various sectors and the entire nation. International investment data are classified more according to behaviour or motivation. To facilitate the analysis of Canada's international financial and economic position the classification puts more emphasis, for example, on whether the long-term investment is for the purpose of establishing management control or is of a portfolio nature.

The direct investment liability category in the international investment position statistics provides a good illustration of the difficulties of recognizing the link between the two systems. In the rest of the world sector of the balance sheet accounts the item is recorded as an asset, and enters into a category labelled 'corporate claims on associated enterprises'. This classification category includes a number of other forms of investment in addition to direct investment, such as equity of nonresidents in Canadian investment abroad through their ownership in Canadian enterprises and non-resident investment in Canadian chartered banks. The reconciliation can only be accomplished with access to worksheet material.

Because the primary source material underpinning both accounts is identical, the reconciliation problems are classificational rather than statistical. Occasionally, differences occur over short periods when the revision policies of the two systems are not fully synchronized.

The gross figures also reflect different degrees of netting in the two systems but in both the overall net international investment position figure is the same. Difficulties normally experienced in linking two independently derived estimates, such as valuation and coverage problems, are absent because of the use of corresponding data.