Asset is what a company has, what a company owns.
As one of the three types of accounts on the Balance Sheet, asset is a crucial element in accounting and financial analysis.
Characteristics of Asset
Assets have the following two characteristics:
1. Items that a company claims ownership of. Such as
2. Resources that will bring in future benefits.
- Cash – Spend them on a company event and boost morale.
- Inventory – Sell them at a good price and enjoy the profit.
- Property – No need to pay rent. Alternatively, sell it later and cash in the appreciation.
- All these are benefits that assets can bring, so you don’t have to worry about employee morale, paying rent, etc.
Have you heard of the phrase “You are an asset to our company”?
- You are part of the company. You don’t work for anyone else at the moment.
- You can provide benefits. You may be a workaholic capable of working 80 hours a week, or you graduated at the top of your class and know how to perform well.
To conclude, assets can be defined as items or resources a company owns and are expected to provide future benefits.
Real-world Simple Example
Asset works quite the same way in a business setting. Asset represents what a company owns that has value and is expected to bring in benefits/income in the future.
Pho my Life Noodle Shop (PML) has the following assets on its balance sheet.
- Cash $500 – The PML noodle shop has $500 in their cash register. The PML noodle shop owns this cash and can spend it to bring in benefits. They can post Instagram ads to bring in more customers or hire an accountant to do tax for them.
- Furniture $2,000 – that’s how much the furniture is worth at the PML noodle shop. The PML noodle shop owns these pieces of furniture and expects them to bring in benefits as well; customers who want to dine in can sit down and hang out with their friends or family. In other words, if the noodle shop doesn’t have these pieces of furniture, they will only attract customers who order to go.
- Kitchen equipment $3,000 = Similarly to the furniture, the PML noodle shop owns 3,000 dollars worth of equipment. Without them, the restaurant wouldn’t even be able to prepare any food. Therefore, it is an asset necessary to bring in future income.
- Prepaid expense $400 = The PML noodle shop has paid money but has not received the benefit yet. For instance, the PML noodle shop prepaid their security service; therefore, in the next 30 days, the restaurant owner will enjoy enhanced safety and peace of mind. This prepaid expense will generate benefits in the future and is, therefore, a typical asset.
Common types of asset
Here is a list of common types of assets – all explained in simple words.
- Cash and cash equivalents: We all know what cash is. Cash equivalents refer to assets that can be quickly turned into cash. For example, Treasury Bills, Certificate of Deposits (CD), Money Market Funds, etc. – all can be sold/turned into cash almost immediately.
- Accounts receivable (AR): The amount of money owed to you by a customer is called Accounts Receivable. For example, if you have fixed your customer’s car and he has promised to pay you back next week, the amount he owes you is an Accounts Receivable.
- Inventory: Items that you own and will sell later or that are necessary for future manufacturing. For instance, if you operate a coffee shop, the coffee beans you buy are considered inventory, as they will be made into coffee later.
- Property, plant, and equipment (PP&E): Items you own that are essential to operate a business. Like kitchen equipment, fireplaces, land, buildings, warehouses, furniture, etc.
- Investments: Stocks, bonds, cryptocurrencies, anything you invested and expected to generate a return or profit. (Note: Cash equivalents, on the other hand, refer to items with little to no risk of loss and can be converted into cash right away.)
- Intangible assets: Items have value but are invisible and untouchable. For instance, intangible assets include the patent of something you invented or a list of customers who are always happy to do business with you.
- Prepaid expenses: Payment you made upfront and expect the service or benefits to arrive later. For example, the rent you must pay at the beginning of the month is a prepaid expense, as the benefit of paying rent is to occupy the office space for the next 30 days, which has yet to occur when you made the payment.
Current assets vs. Non-current assets
The key difference between current and non-current assets is timing – depending on how long you plan to use them or utilize their benefits. The cutoff is one year. Do you expect to utilize the benefits for less than a year? Yes = current assets. No = non-current assets.
Examples of current assets include
- Cash – Cash is always expected to be spent somewhere soon to keep the business running
- Accounts Receivable – AR is normally expected to be collected soon or definitely within a year. Otherwise, most companies will run out of cash.
- Prepaid expenses – typically, prepaid expenses are for services that will be rendered soon, such as rent, utilities, etc.
To conclude, the expectation is that the benefits for the current assets will be utilized or exhausted within a year.
Examples of non-current assets include
- Property, plant, and equipment (PP&E) – include buildings, kitchen equipment, etc. The expectation is that the owner will enjoy the benefits of these assets for more than a year.
- Intangible assets – include goodwill and trademarks, as the benefits these intangible assets provide are long-term, or definitely more than a year.
- Long-term investment – includes any investment the owner intends to hold for more than a year, like bonds, etc.
To conclude, non-current assets are expected to generate benefits for more than one year or be utilized after one year.