Double Entry Bookkeeping and the Distributional Properties of a Firm's Financial Ratios

Our purpose here is to assess whether the innate properties of the double entry bookkeeping system are such that financial ratios, calculated from the balance sheet summary measures implied by it, will be generated by distributional forms with non‐convergent moments. Our analysis begins with a brief summary of some important analytical properties of the debt and equity components of the double entry bookkeeping system. We then use these to determine the time series and distributional properties of the debt to equity ratio itself. Our analysis shows that even when the evolution of balance sheet summary measures like debt and equity can be described by 'well behaved' distributional processes, there is a distinct possibility that ratios derived from them will evolve in terms of distributional forms with non‐convergent moments. We argue that this has serious implications for parameter estimation as well as the integrity of the regression and/or discriminant procedures which underscore bankruptcy and financial distress prediction models based on financial ratios derived from the double entry bookkeeping system.