Asset

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In financial accounting, an asset is any resource owned by a business or an economic entity. It is anything (tangible or intangible) that can be owned or controlled to produce value and that is held by an economic entity and that could produce positive economic value. Simply stated, assets represent value of ownership that can be converted into cash (although cash itself is also considered an asset). [1] The balance sheet of a firm records the monetary [2] value of the assets owned by that firm. It covers money and other valuables belonging to an individual or to a business. [1]

Contents

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. [3] Current assets include inventory, while fixed assets include buildings and equipment. [4] Intangible assets are non-physical resources and rights that have a value to the firm because they give the firm an advantage in the marketplace. Intangible assets include goodwill, copyrights, trademarks, patents, computer programs, [4] and financial assets, including accounts receivable, bonds and stocks.

Formal definition

An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. It is the result of a past event or transaction. [5]

Characteristics

One of the most widely accepted accounting definitions of asset is the one used by the International Accounting Standards Board. [6] 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." [7]

This means that:

Employees are not considered assets, although 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 are also not considered 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. [8]

Accounting

In the financial accounting sense of the term, it is not necessary to be able to legally enforce the asset's benefit for qualifying a resource as being an asset, provided the entity can control its use by other means.

The accounting equation is the mathematical structure of the balance sheet. It relates assets, liabilities, and owner's equity:

Assets = Liabilities + Capital (which for a corporation equals owner's equity)
Liabilities = Assets − Capital
Equity = Assets − Liabilities

Assets are listed on the balance sheet. [9] On a company's balance sheet certain divisions are required by generally accepted accounting principles (GAAP), which vary from country to country. [10] Assets can be divided into e.g. current assets and fixed assets, often with further subdivisions such as cash, receivables and inventory.

Assets are formally controlled and managed within larger organizations via the use of asset tracking tools. These monitor the purchasing, upgrading, servicing, licensing, disposal etc., of both physical and non-physical assets.

Current assets

Current assets are cash and others that are 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:

  1. 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).
  2. Short-term investments – include securities bought and held for sale in the near future to generate income on short-term price differences (trading securities).
  3. Receivables – usually reported as net of allowance for non-collectable accounts.
  4. 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.
  5. 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 :

  1. Investments in securities such as bonds, common stock, or long-term notes.
  2. Investments in fixed assets not used in operations (e.g., land held for sale).
  3. 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 to earn profit in a business. This group includes 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.

These are also called capital assets in management accounting.

Intangible assets

Intangible assets lack physical substance and usually are very hard to evaluate. They include patents, copyrights, franchises & licenses, 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. The physical health of tangible assets deteriorate over time. As a result, asset managers use deterioration modeling to predict the future conditions of assets. [11]

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. [12]

Tangible assets such as art, furniture, stamps, gold, wine, toys and books are recognized as an asset class in their own right [13] . 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.

Wasting asset

A wasting asset is an asset that irreversibly declines in value over time. This could include vehicles and machinery, and in financial markets, options contracts which continually lose time value after purchase. [14] Mines and quarries in use are wasting assets. [15] An asset classified as wasting may be treated differently for tax and other purposes than one that does not lose value; this may be accounted for by applying depreciation.

Comparison: current assets, liquid assets and absolute liquid assets

Current assetsLiquid assetsAbsolute liquid assets
Stocks
Prepaid expenses
Bills receivableBills receivable
Cash in handCash in handCash in hand
Cash at bankCash at bankCash at bank
Accrued incomesAccrued incomesAccrued 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)

See also

Related Research Articles

International Financial Reporting Standards Technical standard

International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company’s financial performance so that company financial statements are understandable and comparable across international boundaries. They are particularly relevant for companies with shares or securities listed on a public stock exchange.

Balance sheet summary of the financial balances of a sole proprietorship, a business partnership, a corporation or other business organization

In financial accounting, a balance sheet or statement of financial position or statement of financial condition is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business partnership, a corporation, private limited company or other organization such as Government or not-for-profit entity. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year.

Historical cost

In accounting, an economic item's historical cost is the original nominal monetary value of that item. Historical cost accounting involves reporting assets and liabilities at their historical costs, which are not updated for changes in the items' values. Consequently, the amounts reported for these balance sheet items often differ from their current economic or market values.

In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities. However, in practice, depending on the source of the calculation, book value may variably include goodwill, intangible assets, or both. The value inherent in its workforce, part of the intellectual capital of a company, is always ignored. When intangible assets and goodwill are explicitly excluded, the metric is often specified to be "tangible book value".

Debits and credits amounts added or subtracted to account ledgers

In double entry bookkeeping, debits and credits are entries made in account ledgers to record changes in value resulting from business transactions. A credit entry in an account represents a transfer of value to that account, and a debit entry represents a transfer from the account. For example, a tenant who pays rent to a landlord will make a debit entry in a rent expense account associated with the landlord, and the landlord will make a credit entry in a receivable account associated with the tenant. Every transaction produces both debit entries and credit entries for each party involved, where each party's total debits and total credits for the same transaction are equal. Continuing the example, the tenant will also credit the bank account from which they pay rent, and the landlord will debit the bank account where they deposit it.

An intangible asset is an asset that lacks physical substance; in contrast to physical assets, such as machinery and buildings, and financial assets such as government securities. An intangible asset is usually very hard to evaluate. Examples are patents, copyright, franchises, goodwill, trademarks, and trade names. The general interpretation also includes software and other intangible computer based assets; these are all examples of intangible assets. Intangible assets generally—though not necessarily—suffer from typical market failures of non-rivalry and non-excludability.

Income statement Financial statement of a company: shows the company’s revenues and expenses during a particular period

An income statement or profit and loss account is one of the financial statements of a company and shows the company's revenues and expenses during a particular period.

Valuation (finance) process of estimating what something is worth, used in the finance industry

In finance, valuation is the process of determining the present value (PV) of an asset. Valuations can be done on assets or on liabilities. Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability.

Financial accounting field of accounting concerned with the summary, analysis and reporting of financial transactions related to a business

Financial accounting is the field of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of financial statements available for public use. Stockholders, suppliers, banks, employees, government agencies, business owners, and other stakeholders are examples of people interested in receiving such information for decision making purposes.

Revenue recognition

The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They both determine the accounting period in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned, no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.

Accounting for leases in the United States

Accounting for leases in the United States is regulated by the Financial Accounting Standards Board (FASB) by the Financial Accounting Standards Number 13, now known as Accounting Standards Codification Topic 840. These standards were effective as of January 1, 1977. The FASB completed in February 2016 a revision of the lease accounting standard, referred to as ASC 842.

Goodwill (accounting) Intangible asset

Goodwill in accounting is an intangible asset that arises when a buyer acquires an existing business. Goodwill represents assets that are not separately identifiable. Goodwill does not include identifiable assets that are capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability regardless of whether the entity intends to do so. Goodwill also does not include contractual or other legal rights regardless of whether those are transferable or separable from the entity or other rights and obligations. Goodwill is also only acquired through an acquisition; it cannot be self-created. Examples of identifiable assets that are goodwill include a company’s brand name, customer relationships, artistic intangible assets, and any patents or proprietary technology. The goodwill amounts to the excess of the "purchase consideration" over the net value of the assets minus liabilities. It is classified as an intangible asset on the balance sheet, since it can neither be seen nor touched. Under US GAAP and IFRS, goodwill is never amortized, because it is considered to have an indefinite useful life. Instead, management is responsible for valuing goodwill every year and to determine if an impairment is required. If the fair market value goes below historical cost, an impairment must be recorded to bring it down to its fair market value. However, an increase in the fair market value would not be accounted for in the financial statements. Private companies in the United States, however, may elect to amortize goodwill over a period of ten years or less under an accounting alternative from the Private Company Council of the FASB.

In accounting, finance and economics, an accounting identity is an equality that must be true regardless of the value of its variables, or a statement that by definition must be true. Where an accounting identity applies, any deviation from numerical equality signifies an error in formulation, calculation or measurement.

A financial asset is a non-physical asset whose value is derived from a contractual claim, such as bank deposits, bonds, and stocks. Financial assets are usually more liquid than other tangible assets, such as commodities or real estate, and may be traded on financial markets.

A foreign exchange hedge is a method used by companies to eliminate or "hedge" their foreign exchange risk resulting from transactions in foreign currencies. This is done using either the cash flow hedge or the fair value method. The accounting rules for this are addressed by both the International Financial Reporting Standards (IFRS) and by the US Generally Accepted Accounting Principles as well as other national accounting standards.

Liability (financial accounting) future sacrifices of economic benefits that an entity is obliged to make to other entities as a result of past transactions or other past events

In financial accounting, a liability is defined as the future sacrifices of economic benefits that the entity is obliged to make to other entities as a result of past transactions or other past events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.

International Financial Reporting Standards requirements

This article lists some of the important requirements of International Financial Reporting Standards (IFRS).

An impairment cost must be included under expenses when the book value of an asset exceeds the recoverable amount. Impairment of assets is the diminishing in quality, strength amount, or value of an asset. Fixed assets, commonly known as PPE, refers to long-lived assets such as buildings, land, machinery, and equipment; these assets are the most likely to experience impairment, which may be caused by several factors.

IAS 16

International Accounting Standard 16 Property, Plant and Equipment or IAS 16 is an international financial reporting standard adopted by the International Accounting Standards Board (IASB). It concerns accounting for property, plant and equipment, including recognition, determination of their carrying amounts, and the depreciation charges and impairment losses to be recognised in relation to them.

IFRS 9

IFRS 9 is an International Financial Reporting Standard (IFRS) published by the International Accounting Standards Board (IASB). It addresses the accounting for financial instruments. It contains three main topics: classification and measurement of financial instruments, impairment of financial assets and hedge accounting. The standard came into force on 1 January 2018, replacing the earlier IFRS for financial instruments, IAS 39.

References

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