Do I not even know what a liability is?

CFA Level I
#1

Just started FSA, and so far I like it, believe it or not. Then I run into the equation showing that: Assets = Liabilities + Contributed Capital - dividends - expenses, and so on. But aren’t liabilities a negative and an eventual outflow to a creditor (or something similar). Why are they added to assets? Shouldn’t they reduce total assets? (I know that my mortgage liability is currently reducing my total assets!) I must be missing something painfully obvious.

#2

The liability isn’t reducing the value of the asset, it is reducing how much of the asset you own (your equity in the asset). In your mortgage example say your house is worth $200M, if you have a $100M mortgage than you have $100M in equity, with a $50M mortgage you have $150M in equity, and with a $300M mortgage you have $100M in negative equity. But the asset value is still $200M, no mortgage will change what your house is worth, it’s worth $200M regardless. Your net portion is what changes hence Assets = Liabilities + Equity. Assets (house) $200M = Liabilities (mortgage) $100M + Equity (What you own) $100M

#3

rework the equation… assets - liabilities = owner equity Now does it make sense that liabilities are a claim on assets? You need to look at it as the equation that “balances”, so you have assets, reduce your liabilities, and you are left with equity, and many derivations thereof…

#4

Contributed Capital - dividends = Equity A - L = E Spend some time reviewing this, you’ll get it.

#5

I always remembered ALOE, A-L=OE…but this is veeeeery basic and should be verrry easy for you to know and remember and it should make sense why…Bankin’ had a perfect example in my opinion.

#6

“Assets = Liabilities + Contributed Capital - dividends - expenses” is only true if you are recording assets at purchase price and expenses includes things like depreciation (both of which might be reasonable in some contexts).

#7

Ok, I get it. I was thinking of assets as what I (or the company) owns, rather than what the actual market value of those things are. Makes sense now. JDV - Correct, that was actually just a portion of the formula I was referring to, I was too lazy to type all of it. Good eyes! Thanks everyone, these answers make sense of it.