An asset account is a category within a company’s general ledger account that shows the value of the assets it owns.
Generally, asset account balances are debit balances. This means they are increased with a debit entry (the left side of a T-account) and decreased with a credit entry on the right side of the account balance.
So what are assets? Put simply, assets are items or resources that are owned by companies. These resources are expected to give economic benefits to companies. In other words, an asset is used by a company to generate future revenues or maintain business operations. The prime reason why businesses operate is to generate revenues and make profits. Assets are the resources that allow companies to make these revenues.
Asset Accounts Example
Let’s say an agriculture company purchases land for $100,000 in cash. In this example, the company will account for both an increase and a decrease in assets. Why?
The purchased land is a non-current asset and the land account of the general ledger with be debited with $100,000.
At the same time, the company’s cash (a current asset) is decreasing in value and the account will be credited with $100,000.
Assets, like liabilities, can be separated out into non-current and current assets. Let’s take a look at each type of asset and give some examples of them.
Non-current assets are those assets that have a life of more than a year. These assets are, therefore, long term investments of the company and are generally illiquid. To make it simpler, converting such assets to cash is rather difficult. These assets also depreciate over their useful life and are tailored to meet the long term needs of the company.
Non-current assets can further be divided into tangible & non-tangible assets. Non-Current assets are normally valued to cost and are subject to depreciation & amortization throughout their lifespan.
Tangible assets are also known as fixed assets. As the name suggests, such assets are physical or can be touched. Some examples of tangible/Fixed assets are as follows:
- Land/Land improvements. Land can either be owned or operated on rent. If the land is owned it is considered as a non-current asset. The value of land is extremely high, and they are highly illiquid. The land is the pre-requisite of starting any business. Any improvements made to the land are also classified in the land account.
- Buildings. The cost of acquiring or construction comes under buildings. For most manufacturers and service providers buildings are a must. Manufacturers need factories to manufacture while service providers such as banks and insurance companies need office buildings to cater to their clients.
- Machinery/Computer equipment. Once buildings have been constructed on land, machinery is required to operate a business. Again, a manufacturer would need machines to produce goods. On the contrary, service providers would need computers and other equipment to satisfy their customer’s demands.
- Furniture and fixtures. Furniture & fixtures include desks, chairs, tables cupboards, fittings & racks.
Not all assets are physical. These assets fall in the category of intangible assets and are as follows.
- Data. With the recent influx of technology, data has gained tremendous value. Digital marketing along with social media platforms such as Instagram, Facebook & Snapchat has created a demand for consumer data. Data owned by companies are considered valuable assets. Facebook acquired WhatsApp in February 2014 for a whopping $16 billion. The rationale behind the massive acquisition was date alone.
- Brand name. Brand name or goodwill also holds substantial value. A powerful brand name allows the company to easily charge higher prices from their customers. Brands such as Apple, Coca Cola, and McDonald’s are extremely powerful.
- Patents. Most companies obtain patents for spending substantial amounts in research & development. These patents have massive value and protect companies against competitors who may try to copy the design, idea, or logo.
Current assets are also considered as short-term assets. Unlike Non-current assets, these assets can easily be converted to cash within a year or less. These assets are used to finance short term financing needs. Hence, such assets help companies in their day to day operations. These assets are also valued at market prices rather than cost. Some common examples of current assets are cash.
- Cash in hand. Cash is the most liquid asset a company can own. Cash is cash itself and there is no question of converting it. It is a general and readily acceptable medium of exchange.
- Cash in the bank. Cash in the bank is not quite as liquid as cash in hand as it has to be withdrawn from the bank either through cheque or debit cards.
- Inventory. For most manufacturers, stock or inventory are also current assets. Manufacturers trade inventory to obtain cash. Inventory for most manufacturers is liquid as it can be sold in less than a year. Most automobile companies launch new models every year, which implies that they were able to sell old stock last year.
- Accounts receivable. Companies also sell goods or inventory on credit. These debtors or accounts receivable buy goods with the promise of paying at a later date. Bad debts, at times also result due to this asset. Companies normally create a provision for such doubtful debts.
- Notes receivable. Notes receivable are promissory notes allowing the company to collect amount with addition to interest on an amount lent. Note Receivables may be collected within one year of their issuance.
- Marketable securities. Marketable securities are examples of short-term investments that are made by a company. These securities are easily marketable and converted to cash. Examples of such securities may include T Bills, notes & equity securities.
- Prepaid expenses. Companies often pay bills and expenses in advance. When companies pay in advance, they in effect are paying for the services that may be utilized later; hence a current asset is created.
As discussed initially, assets are items or resources that bring in more money for a company. Therefore, companies must have a strong asset base. A company with a strong asset position is considered as a healthy company. It attracts numerous shareholders by giving out a good impression.
Financial planners must also constantly strive to bring the right balance between assets and liabilities. The right quantity of assets is required to finance liabilities. Companies with high liabilities and low assets can go into grave financial turmoil and suffer immensely.