“Asset” is one of those words that has both a casual meaning and a specificdefinition. Aspart of everyday speech, asset is used favorably: “He’s a real asset to thecommunity.” Butin the business accounting sense, what do finance professionals mean by assets? In thatcontext, an asset is something of value that a company expects will provide future benefit.
Assets are a key component of a company’s net worth. Lenders may also factor in acompany’sassets when issuing loans. As a note, this article only addresses company-owned assets, notRight of Use assets (i.e.leased assets).
What Is an Asset?
The International Financial Reporting Standards (IFRS) defines an asset as “a resourcecontrolled by the enterprise as a result of past events and from which future economicbenefits are expected to flow to the enterprise.”
Put another way, assets are valuable because they can generate revenue or be converted intocash. They can be physical items, such as machinery, or intangible, such as intellectualproperty. Assets are reported on a company’s balance sheet, one of its key financialstatements.
Assets vs. Liabilities
It’s critical to understand the difference between assets and liabilities. A companylistsits assets, liabilities and equity on its balance sheet. Assets are resources a businesseither owns or controls that are expected to result in future economic value. Liabilitiesare what a company owes to others—for example, outstanding bills to suppliers, wagesandbenefits due to employees, as well as lease payments, mortgages, taxes and loans.
As a note, for public companies, leased property and equipment is listed on the balance sheetas both an asset (Right of Use) and a liability (the present value of future leasepayments). Private companies will soon be required to do the same under U.S. GAAP.
Equity is the company’s net worth—the value that would be returned to the ownersorshareholders if all assets were sold and all debts were settled. The relationship betweenassets, liabilities and equity is defined in the “accounting equation,” one ofthe basicprinciples of accounting:
Assets = Liabilities+ Shareholders’ Equity
A business with more assets than liabilities is considered to have positive equity orshareholder value. If assets are less than liabilities, a company has negative equity orowes more than it is worth.
How Assets Work
Assets underpin a company’s ability to produce cash and grow. They are categorizedbased onspecific characteristics, such as how easily they can be converted into cash (forcompany-owned assets) and their business purpose. They help accountants assess acompany’ssolvency and risk, and they assist lenders in determining whether to loan money to acompany.
Types of Assets
Assets can be classified based on a number of criteria. For companies, the correctclassification is critical to financial reporting and evaluating the business’sfinancialhealth. Typically, assets are valued by the expected future cash flows they represent intheir current condition, according to the IFRS.
Personal: Soft personal assets, such as intellect, wit or a winning smileare different than personal financial assets, which contribute to an individual’s orhousehold’s net worth. Examples of personal financial assets include cash and bankaccounts,real estate, personal property such as furniture and vehicles, and investments such asstocks, mutual funds and retirement plans.
Business: Business assets deliver value to a company because they can beused to produce goods, fund operations and drive growth. Assets include physical items suchas machinery, property, raw materials and inventory, and intangible items like patents,royalties and other intellectual property. Companies account for their assets on theirbalance sheet and categorize them based on a set of criteria that reflect their liquidity,or how readily they can be converted to cash, as well as whether they are physical ornonphysical assets and how they’re used to derive value.
Convertible: Convertibility, or liquidity,refers to how readily a business can convert an asset to cash. Assets that are likely to beturned into cash within one fiscal year or operating cycle are called current assets. Whileany asset can be converted into cash within 12 months if the price is sufficientlydiscounted, current assets only include assets that are expected to be convertedinto cash within 12 months.
Current assets include:
- Cash and cash equivalents, such as treasury bills and certificates of deposits.
- Marketable securities, such as stocks, bonds and other types of securities.
- Accounts receivable(AR), or sales to customers on credit that must be paid in the short term.
- Inventory, or the salablegoods and materials a company has on hand.
Non-current assets are items that may not be readily converted to cash within a year.Examples of such assets include facilities and heavy equipment, which are listed on thebalance sheet, typically under the heading property, plant and equipment (PP&E). Not allcompanies use the term “PP&E” on their balance sheet—they may insteadlist non-currentassets under the heading fixed assets, long-term assets or simply non-current assets.
Tangible: Assets that have a physical existence are called tangible assets.They include cash, PP&E, inventory, raw materials or tools and office supplies. Tangibleand intangible assets that are expected to provide an economic benefit beyond the currentyear, such as manufacturing equipment or buildings, are called or “long-lived”assets.
Intangible assets, as the name implies, lack a physical presence. Examples of intangibleassets include right of use assets, patents, copyrights and trademarks, the value of whichcan sometimes be difficult to quantify.
Some tangible and intangible assets are referred to as wasting assets, or assets that declinein value over a limited life span. Tangible assets that qualify as wasting assets includemanufacturing equipment and vehicles, which wear down or become obsolete over time.Intangible assets such as patents also qualify as wasting assets because they have a limitedlifespan before they expire. To reflect wasting assets’ reduction in value over time,accountants reduce the assets’ value on the balance sheet by applying depreciation (fortangible assets) or amortization (for intangibleassets).
Asset Usage: Finally, an asset can be classified as operating ornon-operating based on how a company uses it. Operating assets are necessary to the primaryoperations of a business, such as cash, inventory, factories and patents. For a miningcompany, heavy equipment qualifies as an operating asset, as does a manufacturer’sproduction equipment.
Non-operating assets are not necessary for funding business operations but have otherperipheral value. Examples include short-term investments, marketable securities, interestfrom deposits and administrative computers.
Examples of Assets
There are a wide variety of assets that businesses might have to perform at their highestlevel. They include:
- Cash and cash equivalents
- Accounts receivable (AR)
- Marketable securities
- Trademarks
- Patents
- Product designs
- Distribution rights
- Buildings
- Land
- Mineral rights
- Equipment
- Inventory
- Software
- Computers
- Furniture and fixtures
Three Key Properties of Assets
For something to be considered an asset, it must have three properties:
- Ownership: First, a company must have ownership or control of theasset. This enables the company to convert the asset into cash or a cash equivalent andlimits others’ control over the item. Note, right of use assets aren’talwaysconvertible. Lease agreements often stipulate that the lease cannot be transferred orsold. The ownership property is important when considering an asset’s informalmeaningversus its technical meaning. For example, companies often say their employees are their“greatest asset,” but in terms of accounting, companies don’t havetrue control overthem—employees can easily leave for a new job.
- Economic value: Second, an asset must also provide economic value. Allassets can be sold or otherwise converted to cash, except for some right of use assetssuch as lease agreements. In that way, assets can be used to support production andbusiness growth.
- Resource: Finally, an asset must be a resource, which means it has orcan be used to generate future economic value. This generally means that the asset cancreate future positive cash inflows.
Importance of Asset Classification
Properly classifying assets is important for company leaders to have an accurate picture ofkey financial metrics such as working capital and cash flow. Asset classification can alsohelp a business qualify for loans—it gives the bank a clearer picture of the riskit’staking on—work through bankruptcy and calculate tax liabilities.
Distinguishing operating assets from non-operating assets also helps organizations see howeach asset type drives overall revenue.
Three Classifications of Assets
Business assets can be divided into three different categories based on their convertibility,physical existence and usage. What are these three types of assets?
- Convertibility describes how easily assets can be converted to cash.
- Physical existence describes whether an asset physically exists or is intangible.
- Usage describes the purpose of an object as it relates to business operations.
How Do Assets Play Into Accounting?
Understanding and properly valuing assets is integral to accurate accounting, businessplanning and financial reporting. And in the case of public companies, accurately accountingfor leased assets is required by law. Classifying and valuing assets is critical tounderstanding a company’s cash flow and working capital. Accountants have to properlyclassify assets for purposes such as securing credit and obtaining insurance. They also haveto properly value assets in order to calculate depreciation and amortization for taxpurposes, and to enable the company to sell them if necessary.
Automated Asset Management Solutions
Keeping track of assets can be challenging given the number and diversity of assets a companymay own. Automated assetmanagement solutions offer a way to inventory, categorize and track assets in orderto understand their value and plan operations efficiently. Asset management solutions canalso help to track and plan the operational life cycle of an asset from acquisition todisposal, including operating and maintaining the asset. In addition, automated assetmanagement solutions can help a company comply with shifting government or industryregulations.
Assets include almost everything owned and controlled by a company that’s of monetaryvalueand will provide future benefit. Assets are classified by how quickly they can be convertedto cash, whether they are tangible or intangible, and how a business uses them. Assets are akey component of a company’s net worth and an important factor in its overallfinancialhealth.
Asset FAQs
How can a business tell if something is an asset?
An asset is anything that has current or future economic value to a business. Essentially,for businesses, assets include everything controlled and owned by the company that’scurrently valuable or could provide monetary benefit in the future. Examples includepatents, machinery, and investments.
What are intangible assets?
Intangible assets are non-physical assets that provide value to a company but don’texist inphysical form. Non-physical assets include things like goodwill, reputation,patents andtrademarks, royalties, brand equity, and contractual obligations.
Does labor count as an asset?
Labor is not an asset. In most cases, labor is an expense. Wages payable count as a currentliability to hold salaries that are due to employees at the end of the month or wheneverpayday is.
What’s the difference between current and fixed assets?
Current assets are generally used up within a year and are therefore short-term. They areinvolved in the daily processes of running a business. Fixed assets are those that have alonger lifespan – generally over one year.
