In this guide, I explain the meaning and concept of assets in accounting, their various types, classifications, and examples. Be sure to check out the interactive quiz at the end of the post to test your understanding!
What are Assets Exactly?
In accounting, assets refer to any physical properties such as inventory, vehicles, and buildings, monetary resources such as cash, investments, and receivables, as well as any intangible properties like software and patents that belong to a business and help it earn economic benefits in the future.
Assets are valuable resources that belong to a business, including:
- Physical properties such as buildings;
- Monetary items like cash; and
- Intangible things such as websites and trademarks.
Here are some more examples of the different types of assets.
3 Characteristics of Assets
To help us determine what we can and what we cannot consider as assets, the generally accepted accounting principles (GAAP) state the three essential features you need to look for in assets before recognizing them as such in the accounting books.
1. The asset will provide economic benefits to a business in the future.
Future economic benefits can mean different things for different assets.
Some assets provide direct economic benefits (e.g., inventory), whereas others indirectly contribute to the future cash flows of a business (e.g., office computer).
Here are some examples of assets and their future economic benefits.
- Cash is valuable to a business because it can pay for things in the future, such as salaries of employees, purchases from suppliers, and other assets.
- A machine can help a business to manufacture something that can sell for cash in the future.
- A warehouse can help a business store and retrieve inventory in the future.
- Inventory and receivables can turn into money in the future.
- Advance salary (prepaid expenses) entitles the business to receive the employee’s services in the future against that advance.
2. The business has control over the asset’s use.
A business should be able to obtain benefits from an asset and restrict its access to others.
For example, ownership of a piece of land gives its owner the legal right to construct a building on it for its own use and prevent others from entering the property without permission.
3. The business has acquired control of the asset due to a past transaction or event.
Types of Assets in a Balance Sheet
Many types of assets appear on the balance sheets of organizations. Here are some of the most common types of assets that you will frequently encounter in accountancy.
|Types of Asset||Explanation and Examples|
Fixed Assets / Non-Current Assets
Fixed assets or non-current assets are long-term assets of the business which are expected to be used for at least 12 months. Non-current assets are grouped separately into three categories in the balance sheet, which include property, plant, and equipment, intangible assets, and long-term investments, which are explained below.
Property, Plant, & Equipment
Property, plant, and equipment are tangible physical assets for long-term use within a business rather than resale, such as land, buildings, machinery, equipment, vehicles, furniture, etc.
Intangible assets are also long-term assets, but unlike property, plant, and equipment, they do not have any physical form. These can include things like patents, trademarks, licenses, and goodwill.
These include all forms of debt and equity investments in other businesses and organizations, such as equity stock in other companies and any tangible property acquired for investment purposes rather than internal use. Depending on the maturity of investments, they may be classified as current or long-term assets.
Current assets are short-term assets that are expected to be used up or spent within 12 months in a business. Current assets are more liquid compared to long-term assets, which is why they are shown separately in the balance sheet. Current assets include inventory, receivables, prepayments, short-term investments, cash, and cash equivalents.
Inventory includes trading inventory that is ready for resale (finished goods) and any inventory in unfinished form (raw materials and work-in-progress) that will eventually sell as trading inventory once ready. Besides trading inventory, inventory also includes any stores, spares, and tools kept for internal use besides manufacturing and resale. For example, unused stationery supplies that are kept for office use will end up as stores, spares, and tools assets. Inventory is part of the current assets.
Receivables are also classified as current assets and include any amounts owed to the business by others such as customers.
Prepaid Assets are advance payments for any goods or services that are yet to be delivered. For example, this can include the portion of advance rent payment that will cover any subsequent period. Prepaid assets are normally classified as current assets and are occasionally combined in the receivables total on the balance sheet.
Cash & Cash Equivalents
Cash and cash equivalents are the most liquid assets of a business and are shown as part of the current assets. Besides the obvious inclusion of cash in hand and bank accounts, cash and cash equivalents also include 'near cash' assets such as government bonds and banker's acceptances that have a low risk in terms of value fluctuations and can easily convert to cash in less than three months.
What are not Considered as Assets?
So far, I have explained what assets are, their characteristics, and types, but as an accounting beginner, it’s equally important for you to learn about what are not assets.
First on the list are resources that are unlikely to provide future economic benefits.
For example, if a customer who owed some money to the business files for bankruptcy, it should no longer be a valuable asset in its accounting books.
However, not all things that provide future economic benefits to a business are to be treated as an asset either in accounting. Here are some instances where this is the case.
If we cannot reliably measure an asset’s value, or the business does not control an asset, we cannot identify it as an asset in the accounting books.
For example, a restaurant cannot show its chef as an asset in its accounting books even if it is the most valuable resource of the business because:
- No one can place an objective value on the employee (i.e., lack of measurability).
- The restaurant cannot force its chef to work in the future (i.e., lack of control).
You cannot recognize a future asset now based on the expectation of a transaction or event that hasn’t already happened.
Like all accounting, assets are recognized when a past transaction establishes control over the asset.
For example, suppose a car showroom places an order to purchase a vehicle from the car manufacturer on 1 December 2020. The showroom receives a brand new vehicle on 5 January 2021 and agrees to pay the car manufacturer’s entire sum in 3 months. In the meantime, the showroom is allowed to sell the new vehicle.
From an accounting perspective, the showroom cannot show the new vehicle in its accounting books until the day it has gotten control of the asset (i.e., on 5 January 2021). So if a balance sheet of the car showroom is prepared on 31 December 2020, it will not show the new car in the assets because the event that establishes its control over the asset has not occurred by then.
Lastly, a resource cannot be treated as assets when a business cannot restrict its benefit to others. Examples of such resources are clean air and public utilities.
How much do you know about Assets?
For anything to be classified as an asset in accounting, it must be likely to provide economic benefits in the future.
Which of the following is an asset for a carpet cleaning business?
Printing cost of pamphlets that have already been distributed 2 years ago is a sunk cost that cannot be treated as an asset because it is unlikely to bring in new clients in the future.
Undistributed pamphlets saved for promotion in the future can however be included in the inventory assets.
Assets can only be recognized on the basis of past transactions. So any expected future assets cannot be capitalized now because of the lack of historical transactions.
If however, the owner gets a cash advance on his credit card in the future to fund business expenditures, then that inflow can be treated as an asset. But until then, the potential asset will not show in the books of the cleaning business.
The vacuum cleaner is part of the property, plant, and equipment assets of the business.
An asset whose value cannot be measured is not shown in the balance sheet.
Which of the following is a current asset?
The camera is a current asset of the shop because it is for sale. If the camera was used for any other purpose (e.g. photography of products) it would be classified as a non-current asset.
Lou paid a 3-month advance amounting to $3000 for a small painting studio that she rented on 1 December 2020. The term of the rental agreement is 2 years but the owner can request Lou to vacate the property at anytime by serving a notice. The studio will cost Lou $1000 per month to rent and has a market value of $100,000.
What is the total value of assets that can appear in the balance sheet of Lou Studios on 31 December 2020 resulting from the above transaction?
Part of the advance rent can be shown as a prepaid asset of Lou Studios.
Since only one month would have passed by 31 December out of the three-month period covered by the advance, two months' rent will be recognized as a prepaid asset in the balance sheet.
Lou does not have long-term control of the studio space so it cannot be treated as its non-current asset.
One month's rent has already been used up by the end of December.
Lou does not own the studio space and the rental agreement does not give her much control over the asset either which is why it cannot be treated as a non-current asset in her accounting books.
How many questions did you answer correctly?