I'm coming from non-accounting and non-finance backgrounds. I need help in form of understanding through a question. I want to ask about something related to the balance of a balance-sheet. Fundamentally, The total value of your assets must be equal to the combined value of your liabilities and equity. However, I got confused about the long-term assets that can have their price drop at any given time in the future (i.e. the fixed assets such as Includes property, buildings, machinery and equipment like computers). How is that the balance still be preserved in this case? Say my friend, invested 10 dollars for my computer-mouse then I write the long-term asset in the balance sheet as 10 dollar ( but actually the computer-mouse now is worth 6 dollars only?). I must be lost somewhere reading about basic accounting article. Thanks
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You want to look for Depreciation and Amortization– quidApr 11, 2021 at 16:37
2 Answers
Long term assets are usually balanced out by long term liabilities, e.g. a mortgage on the property (long-term debt). Alternatively, long term equity balances out long term assets. For example, if the long term asset (say, a building) is owned by the company outright, then it's a long term asset on one side and part of shareholder equity on the other side. As you pay off the debt, it decreases and equity increases, thus keeping the balance sheet balanced.
The actual decline in value, e.g. through depreciation, isn't shown on the balance sheet. In the case of depreciation, it would be shown on the income statement as a depreciation expense.
In your example, the value of the mouse has declined, and since it's property of the firm (or the person, for a personal balance sheet) then the equity has declined as well. The actual decline of $4 could be recorded as a depreciation expense on the income statement.
Focusing on the balance sheet, as you requested, an orderly decrease in value of the asset (depreciation) is handled within the Assets section:
... accumulated depreciation is a contra-asset account, meaning it offsets the value of the asset that it is depreciating. As a result, accumulated depreciation is a negative balance reported on the balance sheet under the long-term assets section.
However, a sudden decrease in value of the asset (write-down) is handled in the Assets section by simply reducing the asset's value.
https://www.investopedia.com/terms/w/writedown.asp
In either case, shareholders' equity is reduced by the same amount, to balance the balance sheet. (In detail, an expense related to the depreciation or write-down will cause the income statement to have decreased net income, which will result in a lower retained earnings figure in the Shareholders' Equity section of the balance sheet).
https://www.investopedia.com/ask/answers/10/retained-earnings-statement.asp
