What it means
The accounting definition has three parts, and each one matters. Control means the business can direct the use of the resource and obtain its benefits; ownership is usual but not essential, which is why leased equipment can be an asset.
Past events means the asset must already exist; an intention to buy a machine is not an asset until the machine is bought. Future economic benefits means the resource must be capable of producing cash inflows or reducing cash outflows; a broken machine that can neither be used nor sold is not an asset, however much it cost.
Assets are classified in two main ways. By liquidity: current assets are expected to be turned into cash or used within a year (cash, receivables, inventory, prepayments), and non-current assets will benefit the business for longer (property, plant and equipment, intangible assets, long-term investments).
By nature: tangible assets have physical form, intangible assets (patents, trademarks, software, goodwill) do not, and financial assets are claims on others (shares, bonds, receivables). Most assets are recorded at cost and then either depreciated over their life or tested for impairment when their value may have fallen.
Some, such as investment properties and certain financial instruments, are carried at fair value and revalued each period. Which treatment applies is set by the accounting standards and disclosed in the company's policies.
The definition also explains what is not an asset. A skilled workforce, a strong brand built by the company itself, a loyal customer base and a good reputation are valuable but are not recorded, because their cost cannot be reliably separated from ordinary spending and the business does not control them in the required sense.
This is why the book value of a business often differs greatly from its market value, and why buyers of companies end up recording goodwill.
In practice
Real-world examples.
Example
A bakery's assets include its ovens, its shop fittings, the flour and sugar in the storeroom, the cash in the till and the $2,000 owed by a cafe it supplies.
Example
A software company's most valuable recorded asset is the capitalised development cost of its platform; its most valuable unrecorded asset is its engineering team.
Example
A retailer leasing its stores for ten years records right-of-use assets for those leases under current standards, even though it does not own the buildings.
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 (the accounting equation)
Total Assets = Current Assets + Non-Current Assets
Return on Assets = Net Profit / Total Assets x 100%
Worked example. A small manufacturing company's balance sheet lists:
- Cash: $90,000
- Accounts receivable: $210,000
- Inventory: $180,000
- Prepayments: $20,000
- Current assets: $500,000
- Land and buildings (net): $700,000
- Plant and equipment (net): $350,000
- Software licences (net): $50,000
- Non-current assets: $1,100,000
- Total assets: $1,600,000
If total liabilities are $900,000, equity must be $700,000 ($1,600,000 minus $900,000). If net profit for the year is $128,000:
- Return on assets = $128,000 / $1,600,000 = 8.0%
Asset test. The company has also spent $60,000 on a brand-building advertising campaign and $40,000 on a deposit for a machine to be delivered next month. The advertising is not an asset (no controllable future benefit can be measured) and is expensed. The deposit is an asset (a right to receive the machine) and is recorded as such.Case study
Seen in the real world.
A family engineering business was being sold, and the owner insisted the price should reflect "everything we own". The balance sheet showed assets of $2.1 million. The buyer's due diligence took a different view of several items.
The inventory included $180,000 of parts for a product discontinued four years earlier, with no realistic buyer; that was written down to scrap value. Receivables included $60,000 from a customer that had ceased trading; written off. A fully depreciated but still working milling machine was on the books at zero; the buyer valued it at $45,000.
And the company's 30-year-old brand name, which appeared nowhere on the balance sheet, turned out to be the reason customers kept coming back; the buyer paid $400,000 above adjusted net assets for it, recorded as goodwill. The final price of $2.3 million was close to the owner's number, but almost every line had moved, and the lesson for both sides was that the balance sheet is a starting point for valuing assets, not a conclusion.
Watch out
Common mistakes.
- Treating every purchase as an asset. Spending that produces no controllable future benefit, such as most advertising and training, is an expense.
- Assuming book value equals market value. Most assets are at historical cost less depreciation.
- Forgetting that assets must be funded. A growing asset base financed by short-term debt is a liquidity risk, not a strength.
Questions
People also ask.
Is cash an asset?
Yes, the most liquid one, and it is listed first among current assets.
Are employees assets?
Not in accounting terms. A business does not control its employees in the sense the definition requires, and their value cannot be reliably measured, so they are not recorded.
What is the difference between an asset and an expense?
An asset provides benefits over more than one period and is recorded on the balance sheet. An expense is consumed within the period and is charged to the income statement.
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