What is an Asset?
Definition: An asset is a resource that owned or controlled by a company and will provide a benefit in current and future periods for the business. In other words, it’s something that a company owns or controls and can use to generate profits today and in the future.
In financial accounting, an asset is any resource owned by the business. Anything tangible or intangible that can be owned or controlled to produce value and that is held by a company to produce positive economic value is an asset. Simply stated, assets represent value of ownership that can be converted into cash (although cash itself is also considered an asset). The balance sheet of a firm records the monetary value of the assets owned by that firm. It covers money and other valuables belonging to an individual or to a business.
One can classify assets into two major asset classes: tangible assets and intangible assets. Tangible assets contain various subclasses, including current assets and fixed assets. Current assets include inventory, while fixed assets include such items as buildings and equipment. Intangible assets are nonphysical resources and rights that have a value to the firm because they give the firm some kind of advantage in the marketplace. Examples of intangible assets include goodwill, copyrights, trademarks, patents and computer programs, and financial assets, including such items as accounts receivable, bonds and stocks.
Assets are reported on the balance sheet usually at cost or lower. Assets are also part of the accounting equation:
Assets = Liabilities + Owner's (Stockholders') Equity
What Does Asset Mean?
The two important things to remember about this definition are that an asset is owned or controlled by a company and it can be used to benefit future accounting periods. Not all assets are owned by the company that reports them on their balance sheet. For example, a leased vehicle is not technically owned by the lessee, but it still reports the vehicle as an asset. Likewise, the company doesn’t necessarily have to benefit future periods, but it has to have to ability to benefit them. Cash may only benefit the company in the current period because it is received and spent in the current period. However, cash can be saved and spent in future periods.
An asset can be (1) something physical, such as cash, machinery, inventory, land and building, (2) an enforceable claim against others, such as accounts receivable, (3) right, such as copyright, patent, trademark, or (4) an assumption, such as goodwill. Assets shown on their owner’s balance sheet are usually classified according to the ease with which they can be converted into cash.
Example
The asset account has a debit balance and is reported on the balance sheet in several categories. The main three categories include current, long-term, and intangible.
Current assets are reported first and include resources that can be used in the current year like cash, accounts receivable, and inventory.
Long-term assets include resources like vehicles, buildings, and other things that cannot be consumed in one period. In other words, they benefit the company in both the current and future periods.
Intangible assets are typically presented last in the assets section of the balance sheet because they are unlike current and long-term assets. Intangible resources; like contracts, patents, and trademarks; are not physical in nature and usually have a set expiration date.
As you can see, assets take many different forms including physical and intangible forms and come in many different sizes from large buildings to desktop computers.
How Does an Asset Work?
A company lists its assets on its balance sheet. Common asset categories include cash and cash equivalents; accounts receivable; inventory; prepaid expenses; and property and equipment. Although physical assets commonly come to mind when one thinks of assets, not all assets are tangible. Trademarks and patents are examples of intangible assets.
Assets are presented on the balance sheet in order of their liquidity. Current assets, which are expected to be consumed or converted to cash within one year, are listed at the top. Cash, short-term investments and inventory are examples of current assets.
Long-term assets, or fixed assets, are expected to be consumed or converted to cash after one year’s time, and they are listed on the balance sheet beneath current assets. Property (such as office space or buildings) and equipment are common long-term assets.
Investors buy assets with the understanding that assets should hold, or even better, grow their economic value over time. Common asset classes for individual investors include stocks, bonds, cash, foreign currencies, collectibles, precious metals, real estate and commodities. A collection of assets is called a “portfolio,” and it is widely believed that an individual’s portfolio should include assets from several different categories, a process called “asset allocation.”
Characteristics of an Asset
One of the most widely accepted accounting definitions of asset is the one used by the International Accounting Standards Board. The following is a quotation from the IFRS Framework:
“An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.”
This means that:
- The probable present benefit involve a capacity, singly or in combination with other assets, in the case of profit oriented enterprises, to contribute directly or indirectly to future net cash flows, and, in the case of nonprofit organizations, to provide services;
- The entity can control access to the benefit;
- The transaction or event giving rise to the entity’s right to, or control of, the benefit has already occurred.
Employees are not considered assets like machinery is, even though they can generate future economic benefits. This is because an entity does not have sufficient control over its employees to satisfy the Framework’s definition of an asset. Resources that are expected to yield benefits only for a short time can also be considered not to be assets, for example in the USA the 12 month rule excludes items with a useful life of less than a year.
Similarly, in economics an asset is any form in which wealth can be held.
There is a growing analytical interest in assets and asset forms in other social sciences too, especially in terms of how a variety of things (e.g. personality, personal data, ecosystems, etc.) can be turned into an asset.
Current Assets
Current assets are cash and other assets expected to be converted to cash or consumed either in a year or in the operating cycle (whichever is longer), without disturbing the normal operations of a business. These assets are continually turned over in the course of a business during normal business activity. There are 5 major items included into current assets:
- Cash and cash equivalents – it is the most liquid asset, which includes currency, deposit accounts, and negotiable instruments (e.g., money orders, cheque, bank drafts).
- Short-term investments – include securities bought and held for sale in the near future to generate income on short-term price differences (trading securities).
- Receivables – usually reported as net of allowance for non-collectable accounts.
- Inventory – trading these assets is a normal business of a company. The inventory value reported on the balance sheet is usually the historical cost or fair market value, whichever is lower. This is known as the “lower of cost or market” rule.
- Prepaid expenses – these are expenses paid in cash and recorded as assets before they are used or consumed (common examples are insurance or office supplies). See also adjusting entries.
Marketable securities: Securities that can be converted into cash quickly at a reasonable price.
The phrase net current assets (also called working capital) is often used and refers to the total of current assets less the total of current liabilities.
Long-term Investments
Often referred to simply as “investments”. Long-term investments are to be held for many years and are not intended to be disposed of in the near future. This group usually consists of three types of investments:
- Investments in securities such as bonds, common stock, or long-term notes.
- Investments in fixed assets not used in operations (e.g., land held for sale).
- Investments in special funds (e.g. sinking funds or pension funds).
Different forms of insurance may also be treated as long term investments.
Fixed Assets
Also referred to as PPE (property, plant, and equipment), these are purchased for continued and long-term use in earning profit in a business. This group includes as an asset land, buildings, machinery, furniture, tools, IT equipment, e.g., laptops, and certain wasting resources e.g., timberland and minerals. They are written off against profits over their anticipated life by charging depreciation expenses (with exception of land assets). Accumulated depreciation is shown in the face of the balance sheet or in the notes. An asset is an important factor in a balance sheet.
These are also called capital assets in management accounting.
Intangible Assets
Intangible assets lack of physical substance and usually are very hard to evaluate. They include patents, copyrights, franchises, goodwill, trademarks, trade names, etc. These assets are (according to US GAAP) amortized to expense over 5 to 40 years with the exception of goodwill.
Websites are treated differently in different countries and may fall under either tangible or intangible assets.
Tangible Assets
Tangible assets are those that have a physical substance, such as currencies, buildings, real estate, vehicles, inventories, equipment, art collections, precious metals, rare-earth metals, Industrial metals, and crops.
Depreciation is applied to tangible assets when those assets have an anticipated lifespan of more than one year. This process of depreciation is used instead of allocating the entire expense to one year.
Tangible assets such as art, furniture, stamps, gold, wine, toys and books have become recognized as an asset class in their own right and many high-net-worth individuals will seek to include these tangible assets as part of their overall asset portfolio. This has created a need for tangible asset managers.
Comparison: current assets, liquid assets and absolute liquid assets
| Current assets | Liquid assets | Absolute liquid assets |
|---|---|---|
| Stocks | ||
| Prepaid expenses | ||
| Bills receivable | Bills receivable | |
| Cash in hand | Cash in hand | Cash in hand |
| Cash at bank | Cash at bank | Cash at bank |
| Accrued incomes | Accrued incomes | Accrued incomes |
| Loans and advances (short term) | Loans and advances (short term) | Loans and advances (short term) |
| Trade investments (short term) | Trade investments (short term) | Trade investments (short term) |
Summary
- An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.
- Assets are reported on a company’s balance sheet and are bought or created to increase a firm’s value or benefit the firm’s operations.
- An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses or improve sales, regardless of whether it’s manufacturing equipment or a patent.