What it means
To count as an asset in the accounts, an item must be controlled by the business as a result of a past event and be expected to produce future economic benefit. A delivery van the company bought last year qualifies, while a customer relationship the company simply hopes to build does not.
Control matters more than legal ownership in some cases, which is why certain leased items now appear as assets. Assets are usually split into current and non-current groups.
Current assets, such as cash, receivables (money customers owe) and inventory, are expected to turn into cash within a year. Non-current assets, such as buildings, machinery and long-term investments, are held for longer.
There is also a split between tangible and intangible assets. Tangible assets can be touched, like vehicles and equipment, whereas intangible assets such as patents, brands and software have no physical form.
Both are recorded at a cost less any depreciation or amortisation, and sometimes at fair value, depending on the type and the accounting framework. Assets are funded either by owners or by lenders, which is why the balance sheet always balances.
Everything the business owns equals what it owes to outsiders plus what belongs to the owners. A rising asset figure is not automatically good news, because it might be financed by borrowing.
Managers care about whether assets are being used productively, which is why ratios such as return on assets and asset turnover exist. An asset that sits idle, or that is worth less than its book value, can quietly weaken performance.
Impairment is the safeguard that stops assets from being overstated. If the amount a business expects to recover from an asset falls below its carrying value, the difference must be written off as a loss.
This is why a sudden fall in demand, or a damaged piece of equipment, can reduce asset values in the accounts overnight.
In practice
Real-world examples
Example 1
A bakery buys an industrial oven for $40,000. It records the oven as an asset and depreciates it over ten years, so $4,000 is charged to profit each year.
Example 2
A consulting firm has $90,000 of unpaid invoices from clients. These receivables are current assets because the firm expects to collect the cash within a few months. The finance team monitors them each week.
Example 3
A technology company spends $250,000 developing software that it will sell for years. If it meets the accounting rules for capitalisation, the cost is recorded as an intangible asset instead of being expensed at once. The software is then amortised over its expected useful life.
Think of it
An asset is like a tool in your toolbox. Each tool has value and helps you accomplish tasks, whether it's a hammer you use daily or a specialty tool you need occasionally.
Formula
Calculation
Assets = Liabilities + Equity
Suppose a small design studio owes $300,000 to lenders and suppliers, and its owners have $200,000 of equity. Total assets = 300,000 + 200,000 = $500,000. These might be made up of cash of $80,000, receivables of $120,000, equipment of $250,000 and software of $50,000. Check: 80,000 + 120,000 + 250,000 + 50,000 = $500,000, which matches the total.Case study
Seen in the real world
Oakmere Brewing is an illustrative, fictional craft brewery that wanted to expand. Its balance sheet showed $1,200,000 of assets, but the finance director noticed that $300,000 of that was a bottling line used for only a fraction of its capacity.
She compared the figures with the brewery's revenue and found that every $1 of assets was producing only $0.80 of sales, below the industry norm she had been using. The company decided to sell the bottling line and outsource bottling instead.
The sale released cash that paid down a loan, and sales per dollar of assets improved. This illustrative case shows that the presence of an asset on the balance sheet says little about how well it is working. The finance director also set a rule that any new equipment purchase must show an expected return before it is approved, so the brewery would not repeat the mistake.
Watch out
Common mistakes
- Assuming everything useful to the business is an asset, when items such as a skilled team or a strong reputation usually cannot be recorded because the business does not control them in the accounting sense.
- Treating the book value of an asset as its market value, when depreciation and market changes can make the two very different.
- Counting spending as an asset, when many costs, such as routine repairs and advertising, are expensed immediately.
Questions
People also ask
What is the difference between an asset and an expense?
An asset gives benefit over several periods and is recorded on the balance sheet, while an expense is used up in the current period and charged to profit.
Are all assets physical?
No, intangible assets such as patents, trademarks and software are also recorded when they meet the accounting criteria.
How are assets valued?
Most are recorded at cost less depreciation, though some are carried at fair value or net realisable value, depending on the type of asset.
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