Equity—The “Balance” Part

Why do they call this report a balance sheet? Because accountants always keep the same number of pencils in the left pocket as in the right? Not really. Historically, the term is based on attempts by goldsmiths in the Middle Ages to determine how rich they were, or what their net worth was. These were the forerunners of modern banks. They held gold in safekeeping for other people, they loaned gold to people they trusted, and at times might borrow gold themselves. If they added up the gold they had on hand (assets) and deducted what gold they owed to other people or were holding for them (liabilities), the difference was the gold that actually belonged to them (their net worth). That is, the gold that a goldsmith had on hand should equal, or balance, the gold he owed other people plus the gold that belonged to him.

For goldsmiths and others who dealt only in gold or other monetary media, this worked well. However, when other merchants used the system and came up with a figure of net worth, it was not always a good indication of what they really were worth. If, in 1550, the Earl of East Overshoe had cornered and owned 80 percent of the oats in East Overshoe and West Sneaker, he might have computed his net worth as what he paid for the oats less what he had borrowed from the king to buy the oats. However, if he sold the oats all at once, he would flood the market, the price would go down, and he might not realize even enough to pay back the king, so his net worth would be a negative number. (And in those days, people literally lost their heads over predicaments such as that.)