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Step-by-Step Guide to Understanding Assets in Accounting

Last Updated December 6, 2023

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What is the Definition of an Asset?

Assets are resources containing economic value or can be used to produce future benefits, such as generating revenue on behalf of the company on a later date.

The assets section is one of the three components of the balance sheet, and consists of line items representing positive economic benefits.

  • Assets Section → The assets side of the balance sheet represents the resources utilized by a company to generate revenue growth.
  • Liabilities and Shareholders’ Equity Section → The liabilities and shareholders’ equity section of the balance sheet are the funding sources, i.e. how the asset purchases were financed.

The assets section of the balance sheet is separated into two components:

  1. Current Assets — Current assets, or “short-term assets”, are expected to provide near-term benefits and/or be liquidated within 12 months.
  2. Non-Current Assets — In contrast, non-current assets, or “long-term assets”, are anticipated to generate economic benefits with an estimated useful life in excess of 12 months.

On the balance sheet, the assets section is ordered on the basis of how quickly each item can be liquidated. Hence, “Cash and Cash Equivalents” is the first line item listed on the current assets section.

Current assets are often called short-term assets, since most are liquid and expected to be converted into cash within one fiscal year (i.e. twelve months).

Generally, the current assets of a company are the working capital required by a company for its daily operations (e.g. accounts receivable, inventory).

Assets Formula

The fundamental accounting equation expresses the relationship between assets, liabilities, and shareholders’ equity.

That accounting equation, or “balance sheet equation”, states that the assets will always be equal to the sum of the liabilities and equity.

Total Assets = Total Liabilities + Total Shareholders’ Equity

Conceptually, the formula indicates that a company’s purchase of assets is financed with either:

  • Liabilities → e.g. Accounts Payable, Accrued Expenses, Short-Term and Long-Term Debt
  • Shareholders’ Equity → e.g. Common Stock and APIC, Retained Earnings, Treasury Stock

The assets section comprises items considered cash outflows (“uses”), and the liabilities section is deemed cash inflows (“sources”).

  • Monetary Store of Value → Certain assets, such as cash and cash equivalents (e.g. marketable securities, short-term investments), are a store of monetary value that can earn interest over time.
  • Future Economic Benefit → On the other hand, certain assets are future cash inflows, such as accounts receivable (A/R) – which refer to the uncollected cash payments still owed to the company by customers who paid on credit.
  • Longer-Term Economic Utility → In the final type, there are long-term investments that can be used to derive monetary benefits, most notably property, plant and equipment (PP&E).

Current Assets vs. Non-Current Assets: What is the Difference?

The following table inserted below elaborates on the common types of current assets found on the balance sheet.

Current Assets Description
Cash and Cash Equivalents
  • Cash and cash-like investments such as commercial paper, short-term government bonds, and marketable securities with high liquidity (i.e. can be converted into cash rather quickly).
Accounts Receivable (A/R)
  • A/R refers to uncollected payments owed to a company by its customers for products/services already earned (i.e. an “IOU” from the customer).
  • Inventories consist of raw materials, unfinished goods (work-in-progress), and finished goods ready to be sold — as well as the direct costs associated with producing these goods.
Prepaid Expenses
  • Prepaid expenses refer to payments made in advance for goods/services expected to be received on a later date (e.g. upfront payment of utilities, insurance, and rent).

The non-current assets section includes the long-term investments of the company, whose potential benefits will not be realized in a single year.

Unlike current assets, non-current assets tend to be illiquid, which means these types of assets cannot easily be sold and converted into cash in the market.

But rather, non-current assets provide benefits for more than one year.

Therefore, long-term assets – namely fixed assets (or “PP&E”) and certain intangible assets – are capitalized and expensed on the income statement across their useful life assumption.

  • Property, Plant & Equipment (PP&E) → Depreciation Expense
  • Intangible Assets → Amortization Expense

Tangible vs. Intangible Assets: What is the Difference?

If an asset can be physically touched, it is classified as a “tangible” asset (e.g. PP&E, inventory).

But if the asset has no physical form and cannot be touched, it is considered an “intangible” asset (e.g. patents, branding, copyrights, customer lists).

The chart below lists examples of non-current assets on the balance sheet.

Non-Current Assets Description
Property, Plant & Equipment (PP&E)
  • PP&E consists of long-term fixed assets, such as land, vehicles, buildings, machinery, and equipment, used to manufacture products or to help provide the company’s services to customers.
Intangible Assets
  • Intangible assets are non-physical assets like patents, trademarks, copyrights, and intellectual property (IP), where the values of intangibles are recorded on the books post-acquisition.
  • Goodwill is an intangible asset created to capture the excess of the purchase price over the fair value of an acquired asset (and checked for impairment, rather than amortized).

Operating vs. Non-Operating Asset: What is the Difference?

There is one final distinction to be aware of, which is the classification between operating and non-operating assets.

  • Operating Asset → Operating assets are essential to the core ongoing operations of a company, and generation of revenue over the long-run.
  • Non-Operating Asset → Non-operating assets, in contrast, are not essential to the daily operations of a company, even if they produce income (e.g. financial assets such as marketable securities).

The operating assets belonging to a company play an integral role in the core financial performance.

For example, the machinery and equipment owned by a manufacturing company would be considered “operating” assets.

Conversely, if the manufacturing company invested some of its cash in short-term investments and marketable securities (i.e. public market stocks), such assets would be considered “non-operating” assets.

When conducting diligence on a company to arrive at an implied valuation, it is standard to evaluate the performance of operating assets to isolate the company’s core operations.

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