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Balance sheet estimates at market value

Introduction

In the Canadian System of National Accounts, balance sheet estimates are comprised of two related accounts – The National Balance Sheet Accounts (NBSA) and Canada’s International Investment Position (IIP). The NBSA provides the opening and closing balance sheets to the Income and Expenditure Accounts sector transactions and to the Financial Flow Accounts. The IIP provides the stock dimension to the Financial Account of Canada’s Balance of International Payments.

What is new with the first quarter 2004 balance sheet accounts?

In June 2003, a major step was taken towards improving the links between the Canadian System of National Accounts' components by converting the NBSA and the IIP to a quarterly frequency. With the June 2004 releases, the analytic usefulness of the accounts is further enhanced as key financial instruments in the NBSA and the IIP are now measured at market value. The additional items now measured at market value are:

• domestic bonds;
• domestic marketable equities;
• domestic investment fund units;
• domestic life insurance and pension units;
• foreign marketable securities.

The market value estimates are to be released in a new five-sector NBSA. This will include market value estimates for the personal sector, the corporate sector (split between non-financial and financial corporations), the government sector and the non-resident sector. The new time series run quarterly from 1990 to 2004. Book value estimates will continue to be released for the 30 sectors of the economy, both from 1961-2003 annually and from 1990 to 2004 on a quarterly basis.

The IIP release does not change, except for the addition of supplementary information on inward and outward portfolio investment at market value. In addition, a supplementary international investment position is calculated, which incorporates the new market value data on securities in the calculation. In terms of geographical allocation, market value estimates are currently available for the US and the rest of the world.

Market value versus book value assets and liabilities, and data needs

Market value data

International standards in national accounting, in particular the SNA 1993 and the fifth edition of the Balance of Payments Manual recommend that assets (and liabilities) be recorded at current/market value or a close approximation thereof¹. This is directly related to the relevance of the data as economic behaviour is based on, among other things, perceptions of wealth positions at current values. Further, economic and financial developments in the last decade underline an analytical need for market value wealth estimates. For example, the strong upward trend in equity investment and prices in the 1990s coupled with recent substantial stock market corrections should be reflected in the evolution of the sectors’ net worth. In addition, the rapid growth in the assets of institutional investors over the last 15 years, and the implications of market swings on these assets, can affect the adequacy of households’ accumulated saving for retirement. Lastly, significant shifts in the composition of saving in the sectors of the economy that emerged in the mid-1990s may be related to underlying changes in net worth.

Statistically, market value estimates provide symmetry in the valuation of assets and liabilities. For example, the underlying market value of firms in the economy is equal to the total of the corporate equities held by investors in the market value framework. This also enhances the interpretability of the data.

Book value data

Book value estimates are generally considered less analytically meaningful, and can be difficult to interpret, since they can be viewed from either the debtor or creditor’s point of view. In other words, book value estimates are typically valued differently on the asset and liability sides of the balance sheet accounts². These differences have had an adverse impact on the quality both in terms of relevance and interpretability of certain assets in the NBSA book value personal sector estimates, in particular, for residually-derived marketable securities. The IIP book value estimates are based on the debtor approach for both assets and liabilities so are more consistent in this respect.

However, book value estimates can be analytically useful in their own right. Some users may be interested in what government debt is at any point in time, on the basis of what they would have to repay. In other instances, users may want to compare debt-to-equity ratios for corporations with equity at book and market values.

Therefore book value estimates are retained for analytical as well as practical reasons. In the case of the NBSA, the considerable sub-sector detail that users have become accustomed to is only available on a book value basis. In the case of the IIP, the book value estimates continue to be the core set of data for the time being.

Approach to developing market value estimates

Non-financial assets

In the NBSA, non-financial assets were added to partial balance sheet accounts (financial assets and liabilities) in 1984. In summary, the non-financial assets represent reliable approximations to market values. The methodology to construct the estimates has provided current values of produced assets and land³. Recently added (1997) estimates of natural resources are net present value estimates⁴.

Financial instruments

For financial assets and liabilities, market values have been derived by estimating and linking control total market value estimates for the liability-side bonds and stocks to the corresponding market value asset-side values. There are two main financial instruments from which market value control totals are derived: Corporate equity liabilities and bonds. These are split between domestic and foreign investment.

a) Control total liabilities

Marketable domestic corporate equities are estimated on the basis of the values assigned them in the market. Unlisted shares, as well as inter-company investments, are not currently moved to market value⁵. Thus corporate share liabilities are stratified into two groups: listed, widely-held portfolio investment shares at market value; and, un-listed shares plus listed shares held as inter-company investment at book value⁶. The market value of all listed companies shares is based on information taken from the exchanges and reconciled to survey data. Micro-data are used extensively in the process in order to ensure that total corporate share liabilities, by component, are accurately measured. Market-to-book ratios are derived by company and by industry using this approach.

The market value of domestic bond liabilities is estimated using micro-data in a debt inventory system. This system records all of the characteristics of outstanding marketable bonds, allowing for the calculation of the present value of each bond. These values are then aggregated by type to produce total bonds (e.g., federal, provincial, corporate) at market value. In earlier years, where coverage is not complete for certain bonds, the implicit market-to-book ratios derived for a portion of the bonds are applied to the book value of outstanding bonds in order to estimate the total market value.

Lastly, the control total Canadian foreign portfolio investment (in stocks and bonds) is measured principally using the Canadian Portfolio Investment Survey. This annual survey collects micro data on the market value holdings of securities of large institutional investors. Quarterly estimates are derived using flows, price and currency changes.

b) Assets

Turning to the asset side, non-resident sector assets – essentially holdings of Canadian marketable debt – are constructed using the previously mentioned debt inventory system. For non-resident holdings of Canadian equity, annual survey results on the holdings are re-valued using market-to-book ratios⁷, with quarterly positions derived using flows and price changes.

For the assets of the major domestic institutional sectors (e.g., pension funds, segregated funds of life insurance companies, mutual funds), market value data are readily available from Statistics Canada surveys and other sources⁸. For other sectors, where holdings of marketable stocks and bonds are considerably less significant, the derived average asset market-to-book ratio of the institutional investors is used to estimate a market value.

Based on the above, there are two calculations that give rise to changes in the valuation of household sector assets. First, the personal sector holdings of share and bond assets are derived residually. Second, life insurance and pension assets of households are derived as the counterpart of: assets at market value less current payables in the insurance and pension sectors.

Brief overview of forthcoming developments

In the process of calculating the new estimates, some additional breakdowns have been produced. For example, the split of corporate shares between marketable securities, investment fund units and equity in private corporations is now being calculated for certain sectors. It is expected that some of this new detail will be available over the course of the year 2004. While only the five sector market value NBSA are available with the June 2004 release, additional data on selected institutional investors with assets at market values may also be made available in 2004.

Seasonally-adjusted sector balance sheet estimates are under development, as are real estimates of national wealth. It is expected that these data be available with the second quarter of 2004.

Areas that will be examined in 2005 are the valuation of inter-company investment, including inward and outward foreign direct investment, money market instruments and international reserves.

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1	This is the general recommendation in the System of National Accounts 1993. In fact, only certain assets (non-financial assets and marketable securities) are recommended to be valued at market.
2	For example, on the liability side, corporate equity at book value is comprised of shares outstanding, contributed surplus and retained earnings and reserves; whereas, on the asset side, corporate equity is defined as shares at acquisition cost.
3	For example, produced assets are calculated using a perpetual inventory model (PIM) which yields a depreciated replacement cost value. Refer to A Guide to the Financial Flow and National Balance Sheet Accounts, Statistics Canada Catalogue no. 13-585.
4	Refer to Econnections, Linking the Environment and the Economy, Statistics Canada Catalogue no. 16-505-GPE.
5	International standards do not currently provide clear guidance on the valuation methods for these assets and further research is underway on this issue.
6	Book value, in this case, is corporate equity and is equal to: shares plus contributed surplus plus retained earnings and reserves.
7	Those ratios constructed in the process of developing market value control total Canadian corporate equity liabilities.
8	It is expected that more market value data will become available in the future, as the content of Statistics Canada surveys are revised.