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Replacement risk arises when a bank has an obligation to one party where the discharge of that obligation is conditional on a third party meeting its obligation to the bank. For example, the bank may have sold stock to the first party. It intends to deliver this stock using stock it has bought but not yet received from a third party. If the third party fails to deliver its stock the bank will have to buy it from the market at a potentially higher price.
The most common primary cause of bank failures is insolvency arising from credit losses. This is followed by failure to manage interest rate risk and foreign exchange risk. Failures arising from fraud, market risk and liquidity risk tend to hit the headlines but are far less common than those due to these first two factors.

The balance sheet, prepared as of a specific date, records the categories and amounts of assets employed by the business (i.e., the resources committed) and the offsetting liabilities incurred to lenders and owners (i.e., the funds obtained). Also called the statement of financial condition or statement of financial position, it must always balance. By definition, the recorded value of the total assets in- vested in the business at any point in time must be matched precisely by the recorded liabilities and owners’ equity supporting these assets. Liabilities are specific obligations that represent claims against the assets of the business, ranking ahead of the owners in repayment priority. In contrast, the recorded shareholders’ equity in effect represents a residual claim of the owners on the remaining assets after all liabilities have been subtracted.
The major categories of assets, or resources committed, are:
•    Current assets (items that turn over in the normal course of business within a relatively short period of time, such as cash, marketable securities, accounts receivable, and inventories).
•    Fixed assets (such as land, mineral resources, buildings, equipment, machinery, and vehicles), all of which are used over a longer time frame.
•    Other assets, such as deposits, patents, and various intangibles, including goodwill that arose from an acquisition.
Major sources of the funds obtained are:
•    Current liabilities, which are obligations to vendors, tax authorities, employees, and lenders due within one year or less.
•    Long-term liabilities, which are a variety of debt instruments repayable beyond one year, such as bonds, loans, and mortgages.
•    Owners’ (shareholders’) equity, which represents the recorded net amount of funds contributed by various classes of owners of the business as well as the accumulated earnings retained in the business after payment of dividends.
Balance sheets are static in that, like snapshots, they reflect conditions on the date of their preparation. They’re also cumulative because they represent the effects of all decisions and transactions that have taken place since the inception of the business and have been accounted for up to the date of preparation.
As we indicated earlier, financial accounting rules require that all transactions be recorded at costs and values as incurred at the time, and retroactive adjustments to recorded values are made only under very limited circumstances. As a consequence, balance sheets (being cumulative) display assets and liabilities acquired or incurred at different times. Because the current economic value of assets can change, particularly in the case of longer-lived items (such as buildings and machinery) or basic resources (such as land and minerals), the costs stated on the balance sheet are not likely to reflect true economic values. Moreover, changes in the value of the currency in which the transactions are recorded can, over time, distort the balance sheet.
Ultimately, the recorded book value of owners’ equity is affected by all of these value differentials. There generally is quite a divergence between this residual accounting value and the current economic value of the business as reflected in share prices or in valuations for acquisition. In fact, the shares of successful companies are usually traded at price levels far above their recorded book value.
Finally, a number of relatively recent accounting rules require the estimation and recording of contingent liabilities arising from a variety of future obligations, such as pension and health-care costs, further introducing a series of value judgments. These are frequently shown as “other liabilities,” listed just ahead of shareholders’ equity, and, in effect, amount to a reclassification from being part of the owners’ residual claims, to a special form of long-term liability.
The accounting profession’s FASB is expending a great deal of effort to re- solve these and other issues affecting the meaning of the balance sheet, but only with partial success. Accounting standards continue to evolve, and a manager or analyst must be aware of the underlying issues and processes when reviewing and analyzing this statement.