Understanding Asset in Accounting

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To every person, an asset is anything of value, such as a house, automobile, investments, work of art, or home appliances, furniture, and fixtures.  It can also include skills, hard word, and talents as these things can make a person earn more money.  In the world of Accounting, it almost means the same thing.  

Technically speaking, an asset is a resource that has economic value and owned or controlled by a company and utilized at any given point of time, be it at the moment or the future, to generate income.  These resources come in many forms, and accordingly, are recorded separately.  

For example, cash and building are both considered as company assets, but are recorded separately in the books of accounts or accounting records.  Their separate values are then shown on the Statement of Financial Position or Balance Sheet up to the time when they are utilized.  

Once spent or used, they are taken up in the Profit and Loss Statement or the Income Statement as expenditures.  To illustrate, let us say you plan to launch a small business at home.  This idea was inspired by your friends who frequently ask you to bake some macaroons for them.  So, to do this, of course, you need a little capital or equity to get the ball rolling.   

With $1,000 initial investment, you bought an oven, cooking tools, ingredients, and packaging materials.  After doing the math to set up your selling price per box of 12, you then advertised your business and started getting orders.  As you were able to sell your macaroons at 200% mark-up, you were able to generate revenue from your assets.

From the income, you eventually were able to accept more orders and even needed to expand production to meet the demand.  In this example, different assets came into the picture.  First, the business acquired tools, equipment, and raw materials in the form of an oven, kitchen utensils, ingredients, and packaging materials from the first cash investment.  

Second, the business used its existing assets to buy more assets in the form of inventory when it purchased more ingredients and packaging materials its cash.  And to all companies, assets are always equal the liabilities and equity under the basic accounting equation.  

Sources of Assets

Generally, the assets of a business come from the first investment of its owner or owners.  Depending on the nature of the trade, this may be in the form of cash, land, equipment, raw materials, finished goods, inventory, vehicle, loans, building, prepaid expenses, business revenue, and notes.  Assets may also be bought to increase the value of a business or to help its operations.  In summary, assets come from the equity of the owners, liabilities to creditors, and income from operations. 

Types of Assets

When shown on the Statement of Financial Position or Balance Sheet, assets are typically categorized based on their availability for use, convertibility to cash, and physical existence.  So, a resource readily available for use within the year is a Current Asset.  

In contrast, resources that are likely to be consumed or used after a year are Non-current or Long-term Assets.  Current and non-current assets are split further into different smaller groups.  For example, long-term assets that have a physical presence include Fixed Assets, while those not having a physical existence are Intangible Assets.  

Resources that do not fit any of these classifications are Other Assets.  Classifying assets exist essential to any business because understanding which resources are current and which stay as long-term is crucial in knowing the working capital, at the net of liabilities, of a company.  

Understanding intangible and tangible company assets facilitate the assessment of risk and solvency in a high-risk industry.  Also, determining which resources are used in operation and which resources are non-operating is vital towards understanding the impact of income from each resource.  

Also, this is vital in finding out what fraction of the revenues of a company originates from its main business activities.  Always remember that current assets exist typically shown in the Balance Sheet in their respective liquidity order.  That means that the items most expected to be turned into cash stay ranked higher.  

The typical current assets order starts with cash, broken down into currency, bank accounts, and change and petty cash funds; short-term investments, accounts receivable, inventories, and prepaid expenses.  Now, let us take a closer look at the groups composing each primary type of asset.

Current Assets

  1. Cash and cash equivalents

Cash includes any currency within the coffers of the company, such as petty cash, change fund, cash on hand and in the bank, and foreign currency deposits.  These liquid assets are used to buy other resources, settle debts, and pay for the cost of operation.  

Cash equivalents take in short-term government bonds, marketable securities, bank time deposits, treasury bills, money market holdings, and commercial paper that mature in less than three months.  Anything liquid and devoid of material variations in value is recorded under cash equivalents in the accounting books.  Please take note that companies showing a healthy CCE or cash and cash equivalents in their Balance Sheet reflects an excellent ability to settle their short-term obligations.

  1. Accounts Receivable

Since almost all companies transact business in cash and on account, accounts receivable records sales that are subject to collection within 12 months.  If a company is selling at longer credit terms to its consumers, the portion subject for collection within the year is recorded as a current asset.  The portion of the amount to be collected after a year is then recorded as a non-current asset.  

Also, some accounts may just be partially paid by the customers.  When this happens, it is reflected as an Allowance for Doubtful Accounts in the accounting records.  The amount of the allowance is deducted from the Accounts Receivable balance.  

If the account stays not paid by the customer, it is noted down by way of a Bad Debt, an expense reflected in the Income Statement, and no longer considered under current assets in the Balance Sheet.

  1. Investments

Typically consisting of bonds and stocks, these investments are for selling within the current year by the company.  

  1. Inventory

This account title represents merchandise that a company sells to generate profit, which may either be manufactured, assembled, or purchased.  Hence, it includes raw materials, work in progress, finished goods, and even office supplies.  

Different methods in accounting are used in computing the value reflected in this section as it largely depends on the merchandise sold and the trade sector involved.  For example, at hand may be little assurance that 12 units of expensive heavy equipment can be sold within a year.  

In contrast, a somewhat bigger chance may exist in successfully selling a million face masks or face shields in 2020.  It should be noted that Inventory is not liquid when compared to accounts receivable.  

Still, it is an asset with its ending balance reported in the Balance Sheet by way of a current asset.  The Inventory movements remain a part of the computation of Cost of Goods Sold stated on the Profit and Loss Statement. 

  1. Prepaid expenses

This account title represents advance payments to suppliers for services and goods for delivery within the year.  Although not convertible to cash, these payments are already made by the company.  Such components make space for other employments of the capital.  Prepaid expenses include outflows to contractors and insurance companies, among many others.

These assets may also be classified by way of non-current assets when the future gain is expected to occur a year later.  For instance, if prepaid rent is for two years, half of the amount is taken up in the books as a current asset and the other half as a non-current asset.  The total figure of Current Assets is of crucial importance to management for the daily business operation.  

Management has to be ready towards spending the necessary money as loans and bills become payable monthly.  The currency value of the Current Assets reflects the cash position of the company and permits management to make the necessary provisions for continuing business operation.    

Additionally, investors and creditors keep an eye on these current assets to weigh the risk and value involved in the operations of the company.  Many use various liquidity ratios that represent a group of monetary metrics used towards determining the ability of a debtor to settle current debts without raising more capital.  Such universally used percentages take account of the total Current Assets, if not its sections, as a factor in their calculations.

Non-current Assets

Also called by way of Long-term or Fixed Assets, these resources are capitalized, not expensed.  Thus, it means that the business allocates the asset cost over a number of years wherein it is in use, and not reporting as an expense the entire price of the asset when purchased.  Although termed as fixed assets, these resources include asset types that can be transferred from one place to another.  

The unique thing about these assets are that they lose value with time.  For the reason that they give income for a long time, they are expensed unlike other items.  Subject to the asset type, the acquisition cost is amortized when intangible, depreciated when tangible, or depleted when the asset involved is a land.  

And since part of the cost of the asset is expensed each year, the asset value decreases with its amortization and depreciation amount.  These amounts are then shown on the Balance Sheet of the company.  In this way, the corporation gets to match the cost of the asset with its continuing value.  

How the business devaluates the asset determines its book or salvage value stated on the Profit or Loss Statement.  Note that the book value differs from the present market value wherein an asset can be sold.  

The account title, Property, Plant, and Equipment or PP&E, encompass land, buildings, vehicles, machinery, computer hardware and software, besides furniture and fixtures.  It represents a long-term physical item that a company owns and employs in its business to generate revenue.  

They are non-current assets, referred to by way of capital assets, because they cannot be converted into money or consumed within 12 months from the date of purchase.  For example, when a company markets produce, transport trucks are their fixed assets.  When that same business builds a parking lot for company use, it also is a fixed asset. 

Information about the assets of a corporation help create precise business valuations, financial reporting, and thorough analysis of finances.  Creditors and investors use these details to know the financial health of the company.  In this way, it makes it easier for them to decide to buy more shares or lend cash to the company.

For the reason that companies use an array of accepted ways for recording, decreasing value, and selling their assets, users of financial statements must study the notations to know the manner the figures are determined.  These assets are most important to industries that require a lot of capital, such as industrial firms.

And this is because these companies need significant PP&E investments.  So, when a company persistently reports a negative net flow in cash for the acquisition of tangible assets, this is a definite sign that the company is growing and in an investment mode.

Intangible Assets

These consist of goods that hold no visible presence, although created.  Examples are a patent or copyrights, brand or trademarks, goodwill, intellectual property, trade secrets, and permits.  

Other Assets

Examples of these assets are deferred tax assets, cash surrender value of life insurance, the unamortized bond issue costs, prepaid pension costs, advances to officers, long-term advance payments, deferred income tax, and a bond sinking fund for future settlement of obligations.