The primary difference between assets and liabilities is that asset is something which is owned by the company so that they can provide economic benefits in the future, on the other hand, liabilities are anything which the organization is meant to pay in future.
What are Assets?
Assets are anything valuable for your company; it can be equipment, building, land or intellectual property. The simple question answered by assets is how much do I have. If you own it, it’s an asset.
Common examples of assets are cash which is the money in your bank account, accounts receivable which is the payment that your customers and clients are supposed to make you, equipment and property, inventory – goods which you have in stock and which you’re planning to sell shortly.
Organizations are seen to invest in bonds, equities and other instruments. Investments or assets for the organization because these investments create direct cash flows.
Liability doesn’t always mean that the company is in the problem. For example, a company may have borrowed a loan for acquisition or merger. Although the liability may seem high currently, if managed well, the company will pay it off and get even better profits in future. On the other hand, high assets does not guarantee high returns for shareholders.
If the company is not investing, then most probably the stocks will remain stable, which may not go well with shareholders.
Types of Assets
There are multiple types of Assets. Few of them are as follows:
1. Current Assets
Current assets are the one which can be liquidated in a year. Current assets are placed first in every balance sheet. Following are the items which can be considered in current assets: short-term investments, trade and other receivables, derivative assets, assets for sale, prepaid expenses, cash and cash equivalent, inventory, prepaid income, current income tax assets, accrued income, foreign currency.
2. Non-current Assets
Non-current assets are also termed as fixed assets. They cannot be easily converted into cash, but if held on for a long time, they provide long term benefit.
Following are few of the non-current assets: property, equipment, land, intangible asset, financial assets, deferred tax asset, goodwill, investments in joint ventures, employee benefit assets, Investment in associates, etc.
Current assets and non-current assets are added together to arrive at total assets in the balance sheet.
3. Tangible assets
As the name suggests, tangible assets are the ones which have a physical existence. Tangible assets are land, plant, equipment, machinery, buildings, cash, etc.
4. Intangible Assets
Intangible assets have value, but they do not have physical existence like tangible assets. Following are few of the examples of intangible assets:
Copyright, trademarks, goodwill, patents, etc. Intangible assets, even though not present, are mentioned in the Balance sheet.
5. Fictitious assets
Fictitious assets are not assets at all. Fictitious means fake or real. Factitious assets are false assets which are not real assets. They are losses or expenses. But because of certain unavoidable circumstances, these expenses or damages cannot be written off during that financial year. This is why they are called Fictitious assets.
The examples of Fictitious assets are loss on debentures issue, preliminary expenses, discount on shares, promotional expenses, etc.
Understanding the net worth of an investment after a few years or calculation of intangible assets owned by organizations like trademarks or patents is called valuation of assets. There are many methods of valuing assets, but first, it is essential to understand why an organization would want to value their assets.
The common reasons for such reservations are capital budgeting, investment analysis or merger and acquisition. All of these activities would require a reservation; there are multiple methods of reservation. Following are the four common ways by which an organization can value its assets:
- Relative value method: under this method, the similar assets are compared, and asset valuation is determined.
- Absolute value method: In the absolute value method, the current value of assets is determined. Organizations commonly use the Gordon model for a single period or DCF valuation model when the asset reservation is for multiple periods.
- Fair value method and the assets should be purchased or sold in fair value only. This is as per US GAAP.
- Option Pricing Model: option pricing model is used for typical types of assets like employee stock options, warrants, etc.
What are Liabilities?
Liabilities are anything that the company is obligated for. For example, if an organization takes a loan from the bank, then the loan would be the liability of the company.
Mortgages, bank loans, unpaid bills or any other sum of money which you go to someone else are all classified under liabilities.
The reason an organization would get involved in liabilities is that for investment purposes. Apart from that, there would be many reasons like if the organization runs out of money they need some external cash assistance to keep the company absolute, then they would need certain loans external assistance. Sometimes an organization has expansion plans by collecting money from debentures or shareholders. After the project is completed and when the time comes, the organization pays back to its debenture and shareholders.
Liabilities should never be confused with expenses because both of them are not similar. Liabilities are the money that is owed by the business to someone else. On the other hand, expenses are the ongoing transactions for which the money is paid by the company so that revenue generation as possible. For example, a loan taken from a bank is a liability, but the monthly phone expenses of all the employees is not a liability.
On the other hand, there are certain expenses that can be treated as a liability. For example, a factory rent, if outstanding, should be treated as a liability because the rent denotes that space is utilized for one year, but the money is not paid. In other words, money is owed to the owner. This is why outstanding rent is a liability, but rent is an expense.
Types of Liabilities
Following are a few of the main types of liabilities:
A current liability is also known as short-term liabilities because these can be paid off within a year. Following are few of the items which are classified under current liabilities:
Trade and other payables, accruals, the financial debt which is of short-term, deferred revenue income, provisions, the derivative liabilities, current income tax liabilities, sales tax payable, payable interests, short-term loans, customer deposits which are deposited in advance, trade and other payments, Accounts Payable, long-term debt, liabilities associated with assets that are held for sale.
These are also known as non-current liabilities because they can be paid off over a long period. Following are few of the items which are considered as long-term liabilities:
Provisions, financial debt, deferred tax liabilities, employee benefit liabilities, other payables.
In the balance sheet, current liabilities and long-term liabilities are added together to arrive at total liabilities.
Liabilities and Leverage
Both liabilities and leverage are connected very strongly. For example, if a company has taken a loan from the bank to buy new assets. If the company uses liabilities so that it can own assets, then the company is said to be leveraged.
This is the reason why the right proportion of debt and equity is good for business. The company could be eventually harmed if the debt is too much, but if it is done in the right proportion, then it is beneficial for the business. The ideal expected ratio of debt and equity is debt 40% and equity 60%.
The net worth calculation is simple words you have calculated your assets and liabilities. Following are the steps to calculate net worth:
Add the entire asset value
Add all the liabilities
Net worth = Assets – Liabilities
For example, The total of all assets of an organization is $ 10,000, and the sum of all liabilities is $ 3500, then the net worth is $ 6500.
Net worth is also termed as equity.
Therefore Assets = Liabilities + Equity
Assets vs Liabilities – Difference between them
|Meaning||It is a source of future benefits for the company||These are obligations of the company which they are expected to pay off|
|Depreciation||Assets are depreciable||Liabilities are not prone to depreciation|
|Increase in account||If an asset is increased, then it would be debited in the income statement||If a liability increases, it is credited from the income statement|
|Decrease in account||If an asset is decreased, then it would be credited from the income statement||If a liability falls, then it would be debited in the income statement|
|Types||There are many types of assets, like tangible, intangible, fictitious, current, non-current, etc.||There are only long term and short term liabilities|
|Cash flow||Generates cash inflow||Generates cash outflow|
|Related to||Resources owned by the company||Loans and debts of the company|
|Formula||Assets = Equity + Liabilities||Liability = Assets - equity|
|Format||Current assets are written first, followed by non-current assets||Current liabilities are written first and then non-current liabilities|
|Interest income and Interest cost||Assets are associated with Interest income. For example, an income is expected against any loans and advances given||Interest is expected to be paid for any liability borrowed. For example, money borrowed from someone will come with interest|
Let us consider that you and your friend are starting up a business. The business can be of any kind. Both of you agree to invest $10,000 in cash to make up an initial investment of $20,000. After you deposit $20,000 in the business of your company, the accounting equation will look something like:
$ 20,000 in cash
Now let us consider that you spend $4000 buying a machine which you require for your business.
So now the accounts will look like:
$ 16,000 in cash
$ 4000 in machinery
Now you decide to take a loan of $5000 to invest.
$ 16,000 in cash
$ 4000 in Machinery
Equity = Assets – Liabilities