Sector Accounts - Introduction
Production Account
To start this introduction, let us apply transaction coding to the case of production of goods and services. The relevant transaction is output (P1) which measures the amount of goods and services produced during the accounting period. In order to generate this output by a particular production process, inputs are required, such as raw materials, energy etc. The costs of these inputs are measured by the transaction intermediate consumption (P2), abbreviated henceforth as IC. The difference between output and IC is known as value added (B1). This definition constitutes one of the fundamental identities of national accounts:
Value Added = Output - Intermediate consumption (AP1)
We can also look at this identity from the accounting point of view. To do so we must collect for each institutional unit resources (representing incoming money flows) and uses (representing outgoing money flows) and present these in a T-account, listing transactions involving resources on the right side and those involving uses on the left side (There is no particular reason for these right / left assignments; they are conventions, universally followed). Seen in this perspective it will come as no surprise that output is a resource and IC is a use. Hence we can draw up our first account for production as follows, here for all units taken together:
Next, we want to include value added in the account. Since it is defined as that part of output not spent on IC it is obviously also a use item and we can add it to the left of the account as follows:
Note that both sides of the account now have equal totals. This is an important first accounting rule AR1:
Account totals on the uses side = Account totals on the resources side (AR1*)
Given this rule we also get another perspective on value added: it is the transaction that ensures equality of resources and uses. Such a transaction is called a balancing transaction (classified with a B code). Properly speaking, value added is the balancing item of the production account. Since this account has only output as resource and IC as use, this implies the earlier identity AP1.
Note that in the above account the code for value added is B1g. The code g stands for gross. This means including consumption of fixed capital (CFC). This transaction (belonging to another account, the capital account) serves to reflect the decline in the value of the fixed assets. This is similar to depreciation as used in business accounting. However, CFC in national accounts is not a method for allocating the costs of past expenditures on fixed assets over subsequent accounting periods. Rather, it is the decline in the future benefits of the assets due to their use in the production process. Gross value added is the balancing transaction for which the difference between output and IC includes an amount for CFC. When the amount for CFC is deducted from gross value added we get net value added (B1n). We can introduce this breakdown in the account as follows:
The production account represents for a particular accounting period the total values for the included transactions for the total economy, which is defined as the entire set of resident institutional units. Residency of each institutional unit is determined by the economic territory where its centre of predominant economic interest lies. The concept of residence is not based on citizenship or legal criteria. Having a centre of predominant economic interest in a territory implies being engaged for an extended period (usually one year or more) in economic activities in this territory.
Next, we can split up the total economy into the three institutional sectors we introduced earlier. We will now slightly change the format of the T-account of the previous section by enumerating the transaction codes and descriptions in the middle of the account, with the uses on the left and resources on the right. The resulting production account now looks as follows:
Note that the institutions on the header are given in mirror image form. The amounts in the total columns are for the total economy, and are identical to the previous account. Note further that the accounting rule AR1* on the equality of left and right totals now applies to each pair of mirror image columns, but only for the last, totals row. Hence we can generalize this rule on the equality of uses and resources as follows:
For each sector: Account totals on the uses side = Account totals on the resources side (AR1)
There is one institutional sector missing: the Rest-of-the-World, or ROW. Transactions between domestic units and ROW related to goods and services are exports and imports. We can add these transactions, and the ROW sector, to the production account:
Note that imports constitute a resource from the perspective of the economy, with money incoming to the ROW (and money outgoing for the economy). Similarly, exports constitute a use item. Note also that there is a second balancing item for ROW, the External Balance of Goods and Services (B11). As for value added, we introduce it to ensure that accounting rule AR1 is met for ROW:
B11 = Imports (P7) – Exports (P6)
The rule AR2 for introducing a balancing item B for a particular institutional sector S can now be made explicit:
Let R stand for the total resources for the sector
Let U stand for the total uses for the sector, excluding the balancing item B
Add to the use column for the sector: B = R – U
Hence, total use for the sector is: U + B, or U + (R – U) = R which is the total resource for the sector; we therefore have verified that our construction of the balancing item respects accounting rule AR1
Note that balancing items are always introduced on the use side.
We have now analyzed the first account of the SNA sequence of accounts in detail. Two further steps are required:
The specification of institutional sectors in more details: e.g. split up the column Corp into separate columns for non-financial and financial corporations, or the column HH into separate columns for households and for NPISH
The further specification of transactions: e.g. split up P1 into P11, P12 and P13, the different types of output. Also, exports and imports can be split up into separate rows for goods and for services
Gross Domestic Product (GDP) can be constructed from gross value added as follows:
GDP consists of the sum for the total economy of gross value added and taxes minus subsidies on products. Note that the GDP derivation only applies to the total economy, not to individual sectors. Also, strictly speaking GDP is not a transaction, it does not have a transaction code. It is a macroeconomic aggregate, consisting of different individual transactions.
Generation of Income Account
After the production account, the next account in the sequence shows how gross value added is distributed to labor, capital, government and, where necessary, flows to and from ROW. This distribution process is called the primary distribution of income. This process is not represented by one single account but by two sub-accounts:
Generation of income account
Allocation of primary income account
The generation of income account shows how value added is distributed to labor (compensation of employees) and government (taxes less subsidies). The distribution to capital appears in the balancing item in this account, operating surplus or mixed income. We will look at the Allocation of primary income account in the next section.
Before we present the generation of income account, we need to answer one question that is still pending: how does the value added as balancing item of the production account enter this new account where its distribution is followed? The answer is implied by accounting rule AR1: all entries on the uses side of an account must have corresponding entries in the resources side so that the account totals match. Now we apply this rule not to the account totals, as in rule AR1, but to the balancing item introduced via rule AR2 to add the same balancing item of the uses side of the first account to the resources side of the second account. To see how this works let us look at the generation of income account:
Indeed, the first line gives net value added from the production account, but now on the resources side so that rule AR1 applies to the uses side of the production account in combination with the resources side of the generation of income account. We can state this as our third accounting rule:
The closing balance on the left side of each account will be the opening balance on the right side of the next account (AR3)
The transactions in the generation of income account are:
Compensation of Employees: total remuneration, in cash or in kind, payable by an enterprise to an employee in return for work done by the latter during the accounting period; it consists of two components, wages & salaries and social contributions
Other Taxes on Production
Other Subsidies on Production
By far the largest part of value added is used to pay for wages & salaries and social contributions. A small part is for net taxes on production and the remainder goes as operating surplus / mixed income to the next account. Note that the taxes and subsidies are on production (D29 and D39) and on not products, as was the case in the derivation of GDP (D21 and D31). All transactions in the generation of income account are on the uses side, with subsidies having negative values.
The balancing item for this account is Operating Surplus / Mixed Income, net. The former term – operating surplus – is used for incorporated units with proper bookkeeping records. The latter term – mixed income – is used for unincorporated units, mainly in the household sector. Note that in this paper we present all balancing items in net terms, and not in gross terms, which could also be done and would have been equally valid.
Note that this account only includes transactions for the domestic economy. There are no items for ROW.
Allocation of Primary Income Account
The allocation of primary income account shows the remaining part of the primary distribution of income. It contains as opening balance operating surplus / mixed income as a resource, which is the remuneration for capital as recorded in the generation of income account. It then adds all other forms of income on the resources side: for labor (compensation of employees), for government (net taxes) and for all sectors the incomes received from sources other than production (property income). On the uses side property income paid is recorded. The balance for this account is called primary income.
The following transactions appear in this account:
Compensation of employees: same as in the previous section, but now on the resources side
Taxes on production and imports, consisting of both taxes and subsidies on products and taxes and subsidies on production
Property income: income receivable by the owner of a financial asset or a tangible non-produced asset in return for providing funds to or putting the tangible non-produced asset at the disposal of, another institutional unit; it consists of:
Interest
Distributed income of corporations (i.e. dividends and withdrawals from income of quasi-corporations)
Reinvested earnings on direct foreign investment
Property income attributed to insurance policy holders
Rent
The account looks as follows:
There is one new feature in this account: property income appears both on the uses and the resources side of the account. This is valid because property income can both be received and paid by an institutional unit. Both property income and compensation of employees may also come from or go to the rest of the world; hence there are also entries in the ROW column. In order to respect the accounting rules, the external balance of goods and services (B11) from the production account must be added as opening balance for ROW on the resources side, and there must be a closing balance, the current external balance, on the uses side for ROW.
Secondary Distribution of Incme Account
The secondary distribution of income account follows the conversion of primary income into disposable income, which is the income available for final consumption. These two types of income are not the same because of the occurrence of redistribution of income. This takes place in the form of the following transactions:
Current taxes on income, wealth
Net social contributions
Social benefits other than social transfers in kind; social transfers in kind are individual goods and services provided as transfers in kind to individual households by government
Other current transfers; these consist of the following:
Net premiums and claims for non-life insurance
Current transfers between different kinds of government units
Current transfers such as those between different households
For all these transactions there can be entries on the left and on the right, as was the case for property income in the previous account. Closing balances are primary income for the domestic sectors and the current external balance for ROW. The account looks as follows:
Use of Disposible Income Account
The two primary distribution of income accounts and the secondary distribution of income account together are known as the distribution of income accounts. The next (and final) current account shows how the available disposable income is used up, mainly on final consumption expenditures. These include expenditures by households and by government. Corporations have no final consumption (they do have intermediate consumption). The other transaction in this account - Adjustment for the change in pension entitlements - is a technical adjustment for the accounting for insurance, which we will not discuss here. There are no entries for ROW in this account, so the closing balance for ROW equals the one from the previous account. Since this is the last current account, this closing balance has an official code: B12, the Current external balance. The closing balance for the domestic economy is Saving. It is that part of disposable income that is not consumed during the current accounting period.
Other Macroeconomic Aggregates
Earlier we looked at the macroeconomic aggregate based on the production account: GDP. Similarly, there are aggregates based on the other current accounts. Here we present three such aggregates:
Gross National Income (GNI)
Gross National Disposable Income
Gross Saving
Remember that GDP is calculated for the domestic economy; there are no transactions with ROW that are included. Gross National Income adjusts GDP for two transactions with ROW, coming from the allocation of primary income account:
Compensation of employees payable to / receivable from ROW
Property income payable to / receivable from ROW
GDP includes products and services produced within a country's borders; GNI includes products and services produced by enterprises owned by a country's citizens. The two would be the same if all of the productive enterprises in a country were owned by its own citizens, and those citizens did not own productive enterprises in any other countries. In practice, however, foreign ownership makes GDP and GNP non-identical. Production within a country's borders, but by an enterprise owned by somebody outside the country, counts as part of its GDP but not its GNI. On the other hand, production by an enterprise located outside the country, but owned by one of its citizens, counts as part of its GNI but not its GDP.
The derivation of GNI from GDP proceeds as follows:
In our example GNI is slightly higher than GDP.
Similar remarks apply to the next aggregate, Gross National Disposable Income, based on transactions from the secondary distribution of income account. Here the flows with ROW are:
Current taxes on income, wealth, etc,
Current transfers receivable / payable
The derivation of Gross National Disposable Income from GNI proceeds as follows:
In our example Gross National Disposable Income is somewhat lower than either GDP or GNI.
The final aggregate, Gross Saving, is based on transactions from the use of disposable income account, and is derived from Gross National Disposable Income as follows:
Accumulation Accounts
When going from the current accounts to the accumulation accounts we change perspective. In the current accounts flows are recorded in terms of uses and resources. Here there are two choices. First, we can look at monetary flows:
Resource = incoming flow; e.g. output is incoming money for enterprises (part of the institutional sector Corp)
Use = outgoing flow; e.g. intermediate consumption is outgoing money for enterprises
Alternatively, we can look at real flows, following physical flows of goods and services:
Resource = outgoing flow; e.g. output is outgoing produced goods and services for enterprises
Use = incoming flow; e.g. intermediate consumption is incoming goods and services used as inputs in production processes of enterprises
Whatever way we look at it, the last current account – the use of disposable income account – closes with savings as balancing item. Following the monetary perspective, this represents surplus money in the economy that can be used for accumulating (building up) new assets. An asset, tangible or intangible, is a store of value that is capable of being owned or controlled. Assets can be financial and non-financial. Non-financial assets can be produced or non-produced. Produced assets included fixed assets, used in production repeatedly over an extended period of time, inventories and valuables. Non-produced assets include natural resources, licenses and marketing assets (including goodwill). Transactions in non-financial assets are recorded the capital account, the first accumulation account.
Assets represent benefits that can be stored or traded by means of payments. Hence financial assets (claims) and liabilities arise. Financial assets include shares and other equity. Transactions in financial assets and liabilities are recorded in the financial account, the second accumulation account.
Accumulation accounts are similar to current accounts, recording incoming money on the right and outgoing money on the left. Here the monetary flows are used to change the stock of assets and liabilities. Given the left / right conventions of the current accounts we get:
Left side: outgoing money to obtain assets -> this side records changes of assets
Right side: incoming money either increasing liabilities, or increasing net worth -> this side records changes of liabilities and net worth
So our T-account presentation as introduced for the current account must change slightly, with uses / resources changing into change of assets / changes of liabilities and net worth. We then obtain the following presentation format:
As in the current accounts there are opening and closing balances and totals for the institutional sectors.
There is also a second group of accumulation accounts recording changes in assets, liabilities and net worth due to other factors.
Account for other changes in volume of assets
Account for revaluation of assets
The first account records change in the volume of assets due to reasons other than transactions in the capital account. Examples are discoveries or depletion of subsoil resources, destruction by political events, such as war, or by natural disasters, such as earthquakes. Such factors actually change the volume of assets, either physically or quantitatively. The second account records changes in assets due to changes in the level and structure of prices. In this case, only the value of assets and liabilities is modified, not their volume.
Capital Account
The capital account records transactions linked to:
Acquisitions of non-financial assets
Capital transfers involving the redistribution of wealth
The right-hand side includes net saving and capital transfers receivable and capital transfers payable (with a minus sign) in order to arrive at that part of changes in net worth due to saving and capital transfers.
Capital transfers are transactions, either in cash or in kind, in which the ownership of an asset (other than cash and inventories) is transferred from one institutional unit to another, or in which cash is transferred to enable the recipient to acquire another asset, or in which the funds realized by the disposal of another asset are transferred. There can be capital transfers to and from ROW. Note that capital transfers are distinguished from current transfers. A current transfer reduces the income and consumption possibilities of the first party and increases the income and consumption possibilities of the second party. Current transfers are therefore not linked to, or conditional on, the acquisition or disposal of assets by one or both parties to the transaction.
Capital transfers can be divided into:
Capital taxes
Investment grants
Other capital transfers
The left-hand side of the capital account records the various types of investment in non-financial assets. The main use transaction is gross capital formation, which consists of the following three components (with AN codes, from Assets Non-Financial, for the asset types also given):
AN11 = Gross fixed capital formation; consists of resident producers' acquisitions, less disposals, of fixed assets during a given period plus certain additions to the value of non-produced assets realized by the productive activity of producer or institutional units
AN12 = Changes in inventories
AN13 = Acquisitions less disposals of valuables
We have already encountered the transaction consumption of fixed capital earlier, when we discussed the difference between gross and net value added. It represents the decline, between the beginning and the end of the accounting period, in the value of the fixed assets owned by an enterprise, as a result of their physical deterioration and normal rates of obsolescence and accidental damage. Because consumption of fixed capital is a negative change in fixed assets, it is recorded, with a negative sign, on the left-hand side of the account as well.
The final transaction on the left-hand side is acquisitions less disposals of non-produced non-financial assets. These assets consist of:
AN21 = Natural resources; e.g. land, mineral and energy reserves
AN22 = Contracts, leases and licenses
AN23 = Goodwill and marketing assets
The balancing item of the capital account is called net lending when positive and measuring the net amount a unit or a sector finally has available to finance, directly or indirectly, other units or sectors, or net borrowing when negative, corresponding to the amount a unit or a sector is obliged to borrow from others.
The capital account for our example is as follows:
Note that the total on the right-hand side is called Changes in net worth due to saving and capital transfers. Remember that this account is only for non-financial assets. Non-financial liabilities do not exist, hence all changes on the right-hand side are changes in net worth. Such changes can occur because of saving or because of capital transfers (this is the reason why payable capital transfers also appear – with a negative sign – on the right-hand side). These changes in net worth reflect the changes in assets recorded on the left-hand side of the capital account. When the changes in assets are lower than the available changes in net worth there will be net lending, i.e. funds are available in the institutional sector. When the changes in assets are higher than the available changes in net worth there will be net borrowing, i.e. funds need to be borrowed by the institutional sector to finance the changes in assets.
Financial Account
With the capital account we have reached the end of the real flows. Value added created by production is used up either on final consumption or on gross capital formation, with additional flows from and to ROW supplying imports and using up exports. The end balance is net lending / net borrowing, with income from the current accounts either in surplus or in deficit. In the former case the surplus can be used to obtain financial assets; in the latter case the deficit needs to be financed by incurring liabilities.
All changes in financial assets and liabilities are recorded in the financial account. It is important to remember that the capital account follows the conversion from savings into non-financial assets, with net lending / net borrowing registering the implication on finances. In the financial account the same net lending / net borrowing is compiled from the changes in financial assets and liabilities.
The financial account records transactions in financial instruments for each financial instrument. These transactions show net acquisition of financial assets on the left-hand side or net incurrence of liabilities on the right-hand side.
The main financial instruments are (with AF codes, from Assets Financial, for the asset types also given):
AF1 = Monetary gold and SDRs
AF2 = Currency and deposits
AF3 = Debt securities
AF4 = Loans
AF5 = Equity and investment fund shares
AF6 = Insurance, pension and standardized guarantee schemes
AF7 = Financial derivatives and employee stock options
AF8 = Other accounts receivable/payable
The opening balancing item of the financial account is again net lending or net borrowing, which appears this time on the right-hand side of the account. Flows with ROW are also included, as before.
For our example the financial account is as follows:
In principle, net lending or net borrowing is should be identical in both the capital and the financial accounts. Hence, the closing balance will be zero for all institutional sectors. In practice, achieving this identity is one of the most difficult tasks in compiling national accounts. We have therefore labeled this closing balance as statistical discrepancy, showing the difference between the measurement of net lending / net borrowing based on data sources used for the capital account and the measurement of net lending / net borrowing based on data sources used for the financial account.
Entries in the financial accounts can be both positive and negative, as was the case for capital transfers in the capital account.
Alternative Compilations of GDP
Earlier we presented GDP as calculated by the output approach from transactions in the production account. There are two other methods for compiling the same GDP, which we will briefly review here. First, we can look at the expenditure categories on which income generated from value added is spent. As we saw earlier, value added created by production is used up either on final consumption or on gross capital formation, with additional flows from and to ROW supplying imports and using up exports. Hence, adding these flows together will give us the same GDP again, as is illustrated in our example as follows:
This method is called GDP by expenditure approach. Note the although the same GDP number is compiled, entirely different data sources are used. The GDP by output approach compiles value added by industry, using data sources on output and intermediate consumption. The GDP by expenditure approach uses data sources on final demand categories (each broken down by special purpose classifications). In practice, both compilations will give different results, so we can again introduce a statistical discrepancy between both estimates. Minimizing this discrepancy is an important aim of national accountants.
There is yet another method of compiling GDP, for which we look at the value added components directly:
This is the GDP by income method. As for the output approach, the compilation is carried out by ISIC industry. As before, the GDP number should be the same in theory as for the other methods, but will be different in practice, because independent data sources on the value added components are used. So again, we will end up with a statistical discrepancy. In practice, this third method is not as important as the two other methods, mainly because of the difficulty of collecting data on operating surplus / mixed income.
Balance Sheets
Business accountants produce profit and loss statements and balance sheets for a company for each accounting period. Similarly, national accountants produce the sequence of accounts as outlined in this paper to record changes in the balance sheet from the beginning to the end of the accounting period. They also construct the actual balance sheets of the country. The following figure gives the opening and closing balance sheet for our example. We only show the total non-financial (AN) and financial (AF) assets as single aggregates. The changes in assets / liabilities and net worth come from the four parts of the account sequence which have an impact on them:
Capital account (left side: P5g+K1+K2; right side: B10.1)
Financial account (left and right sides: total of F1, …, F8)
Other changes in the volume of assets account (split up into changes in AN, AF, net worth)
Revaluation account (also split up into changes in AN, AF, net worth)
The entries in the closing balance sheet are calculated as the sum of the entries of the opening balance sheet and the sum of these four changes in assets / liabilities and net worth.
The full sequence of accounts – current accounts , capital accounts , balance sheets - is known as the system of Integrated Economic Accounts (IEA).