What Is an Asset?

“Asset” is one of those words that has both a casual meaning and a specific definition. As part of everyday speech, asset is used favorably: “He’s a real asset to the community.” But in the business accounting sense, what do finance professionals mean by assets? In that context, 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 a company’s assets when issuing loans. As a note, this article only addresses company-owned assets, not Right of Use assets (i.e. leased assets).

What Is an Asset?

The International Financial Reporting Standards (IFRS) defines an asset as “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.”

Put another way, assets are valuable because they can generate revenue or be converted into cash. They can be physical items, such as machinery, or intangible, such as intellectual property. Assets are reported on a company’s balance sheet, one of its key financial statements.

Assets vs. Liabilities

It’s critical to understand the difference between assets and liabilities. A company lists its assets, liabilities and equity on its balance sheet. Assets are resources a business either owns or controls that are expected to result in future economic value. Liabilities are what a company owes to others—for example, outstanding bills to suppliers, wages and benefits 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 sheet as both an asset (Right of Use) and a liability (the present value of future lease payments). 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 owners or shareholders if all assets were sold and all debts were settled. The relationship between assets, liabilities and equity is defined in the “accounting equation,” one of the basic principles of accounting:

Assets = Liabilities + Shareholders’ Equity

A business with more assets than liabilities is considered to have positive equity or shareholder value. If assets are less than liabilities, a company has negative equity or owes more than it is worth.

Types of Assets

Assets can be classified based on a number of criteria. For companies, the correct classification is critical to financial reporting and evaluating the business’s financial health. Typically, assets are valued by the expected future cash flows they represent in their current condition, according to the IFRS.

Personal: Soft personal assets, such as intellect, wit or a winning smile are different than personal financial assets, which contribute to an individual’s or household’s net worth. Examples of personal financial assets include cash and bank accounts, real estate, personal property such as furniture and vehicles, and investments such as stocks, mutual funds and retirement plans.

Business: Business assets deliver value to a company because they can be used to produce goods, fund operations and drive growth. Assets include physical items such as machinery, property, raw materials and inventory, and intangible items like patents, royalties and other intellectual property. Companies account for their assets on their balance 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 or nonphysical 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 be turned into cash within one fiscal year or operating cycle are called current assets. While any asset can be converted into cash within 12 months if the price is sufficiently discounted, current assets only include assets that are expected to be converted into 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 salable goods 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 the balance sheet, typically under the heading property, plant and equipment (PP&E). Not all companies use the term “PP&E” on their balance sheet—they may instead list non-current assets 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. Tangible and intangible assets that are expected to provide an economic benefit beyond the current year, such as manufacturing equipment or buildings, are called or “long-lived” assets.

Intangible assets, as the name implies, lack a physical presence. Examples of intangible assets include right of use assets, patents, copyrights and trademarks, the value of which can sometimes be difficult to quantify.

Some tangible and intangible assets are referred to as wasting assets, or assets that decline in value over a limited life span. Tangible assets that qualify as wasting assets include manufacturing 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 limited lifespan before they expire. To reflect wasting assets’ reduction in value over time, accountants reduce the assets’ value on the balance sheet by applying depreciation (for tangible assets) or amortization (for intangible assets).

Asset Usage: Finally, an asset can be classified as operating or non-operating based on how a company uses it. Operating assets are necessary to the primary operations of a business, such as cash, inventory, factories and patents. For a mining company, heavy equipment qualifies as an operating asset, as does a manufacturer’s production equipment.

Non-operating assets are not necessary for funding business operations but have other peripheral value. Examples include short-term investments, marketable securities, interest from deposits and administrative computers. Source