Passive: what it is – Dictionary of Economics

Definition of passive

Accounting term that defines the set of debts and obligations pending payment. While the asset shows what a company has invested in, the liability reports on the origin of the funds to make said investments. The total assets of a company must coincide with the total liabilities: the goods and rights must add up to the same as the obligations contracted to obtain them.

The net worth and liabilities of a company is what forms the “financial structure of the company”, and will give us information on the origin of the money that has been invested, that is, on the financing of the goods and rights that appear in the active. This financing will be made up of two large groups: own funds (also called equity) and external funds (debts with third parties). The former will be informed by the initial contributions of the owners (capital) and the undistributed business profits (reserves) The foreign funds are made up of debts contracted with third parties that will have to be repaid in the future.

It is very important to know in a company if it is financed with the own funds of others and in what proportion are both in the same.

The main assets of net worth and liabilities are the following three:

1. Equity: Includes capital (contributions from the partners or owners of the company, either at the time of its incorporation or in subsequent capital increase processes), reserves (profits generated in previous years by the company and not distributed to the owners in the form of dividends), and the results (Profit or loss) for the year. In the event that there are profits, the amount of this item will subsequently be allocated to reserves or to the remuneration of the owners of the company in the form of dividends. If, on the other hand, there are losses, these losses will be incorporated later by reducing the company’s reserves.

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2. Non-current liabilities (long-term debts) These are items that include concepts of external financing and whose maturity is greater than one year. Among them, the loans received and that must be repaid in the long term stand out.

3. Current liabilities (short-term debts or current liabilities) This heading of the balance sheet includes those debts whose maturity is short-term or, what is the same, those debts that must be paid within a year. Among them we can mention: debts with suppliers and short-term creditors and debts with public administrations (Public Treasury and Social Security)

The translation of some of the items that usually appear on the liabilities side of a balance sheet are as follows:

The criterion for the appearance of liability items in a balance sheet is due to enforceability, understood as the rush to return the funds to those who lent them to the company. Thus, the equity and liability items will be ordered from the lowest to the highest demandability. The own funds will be located at the top of the balance sheet and the debts will be ordered according to the term of their maturity, those with immediate maturity being placed at the bottom.

The valuation of liabilities may be made based on the following criteria:

1. Accounting value: The value recorded at the time of the appearance of the liability

2. Fair value: That admitted as equivalent to recent market transactions. In other words, it is the value for which a liability can be settled, between interested and duly informed parties, without being subject to coercion and in full exercise of their independence.

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3. Present value: The value resulting from discounting the expected flows of the liability at a reasonable discount rate.

4. Amortized cost: Recorded amount minus the disbursements made that have occurred.

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