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Assets vs Liabilities

Article bySayantan Mukhopadhyay
Reviewed byDheeraj Vaidya, CFA, FRM

The primary difference between Assets and Liabilities is that Asset is anything which is owned by the company to provide the economic benefits in the future, whereas, liabilities are something for which the company is obliged to pay it off in the future.

Differences Between Assets and Liabilities

Assets and liabilities are the main components of every business. Though these two elements are different, the purpose of both of them is to increase the life-span of business.

According to accounting standards, assets are something that provides future benefits to the business. That’s why business consultants encourage businesses to build assets and reduce expenses. Liabilities, on the other hand, are something that you’re obligated to pay off in a near or distant future. Liabilities are formed because you receive a service/product now to pay off later.

Assets-vs-Liabilities

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In this article, we will go through a comparative analysis of both components and would look at various aspects of them in length.

Assets vs. Liabilities Infographics

Assets vs Liabilities

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If you are new to accounting, you may have a look at this Basic Accounting TrainingBasic Accounting TrainingAccounting is the formal process through which a company attempts to present its financial information in a way that is both auditable and usable by the general public. read more (learn Accounting in less than 1 hour)

What are Assets?

Assets are something that keeps paying you for year/s. For example, let’s say that you have purchased an almirah for your business. It has a lifetime value of 5 years. That means purchasing the almirah allowed you to get paid for the next 5 years from now.

Some assets offer you direct cash inflow, and some provide you in kind. In the almirah example, it gives you 5 years of convenience so that you can keep and store relevant documents.

Now let’s talk about investments. Organizations often invest a lot of money into meaningful equities, bonds, and other investment instruments. And as a result, they get interested in their money every year. Investments are assets to the organizations since these investments can create direct cash flows.

Types of assets

In this section, we will talk about different types of assets.

Current Assets

Current assets are those assets that can be converted into liquidity within a year. In the balance sheet, current assets are placed at first.

Here’re the items that we can consider under “current assets” –

Have a look at the example of current assetsExample Of Current AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more –

 M (in US $)N (in US $)
Cash1200015000
Cash Equivalent1700020000
Accounts ReceivableAccounts ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more4200035000
Inventories1800016000
Total Current Assets8900086000

Non-current assets

These assets are also called “fixed assets.” These assets can’t be converted into cash immediately, but they provide benefits to the owner for an extended period.

Let’s have a look at the items under “non-current assets” –

 M (in US $)N (in US $)
Cash1200015000
Cash Equivalent1700020000
Accounts Receivable4200035000
Inventories1800016000
Total Current Assets8900086000
Investments100000125000
Equipment111000114000
Plant & Machinery5000035000
Total Fixed Assets261000274000
Total Assets350000360000

In the Balance SheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more, we add “current assets” and “non-current assets” to get the “total assets.”

Tangible assets

These are the assets that have a physical existence. As examples, we can talk about –

  • Land
  • Buildings
  • Plant & Machinery
  • Inventories
  • Equipment
  • Cash etc.

Intangible assets

These are the assets that have value but don’t have a physical existence. As examples, we can talk about the following –

  • Goodwill
  • Patent
  • Copyright
  • Trademark etc.

Fictitious assets

To be precise, fictitious assets are not assets at all. If you want to understand “fictitious assets,” just follow the meaning of the word “fictitious.” “Fictitious” means “fake” or “not real.”

That means fictitious assets are fake assets. These are not assets but losses or expenses. But due to some unavoidable circumstances, these losses or expenses couldn’t be written off during the year. That’s why they’re called fictitious assets.

The examples of fictitious assets are as follows –

Valuation of assets

Can we value the assets? For example, how would a business know that what would be the worth of an investment after a few years down the line! Or the organization may want to calculate the value of intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more like patents or trademarks.

Well, there are methods for valuing assets. But why would an organization value without any reason? It turns out that for investment analysisInvestment AnalysisInvestment analysis is the method adopted by analysts to evaluate the investment opportunities, profitability, and associated risks in their portfolios. In addition, it helps them to determine whether the investment is worth it or not.read more, capital budgetingCapital BudgetingCapital budgeting is the planning process for the long-term investment that determines whether the projects are fruitful for the business and will provide the required returns in the future years or not. It is essential because capital expenditure requires a considerable amount of funds.read more, or mergers and acquisitions, valuation of assets would be required.

There are multiple methods through which we can value the assets. There are typically four ways an organization can value its assets –

What are Liabilities?

Liabilities are something that an organization is obligated to pay. For example, if ABC Company takes a loan from a bank, the loan would be ABC Company’s liability.

But why organizations get involved in liabilities? Who would like to get into obligations? The straight answer is often organizations run out of money, and they need external assistance to keep moving forward. That’s why they go to the shareholders or sell the bonds to individuals for pumping in more money.

The organizations that collect money from shareholders or debenture holders invest the money into new projects or expansion plans. Then when the deadline arrives, they pay back their shareholders and debenture holders.

Types of liabilities

Let’s see two main types of liabilities on the balance sheetTypes Of Liabilities On The Balance SheetNotes payable, accounts payable, salaries payable, interest payable, creditor, debenture/bonds, and owner equity are the many types of liabilities on the balance sheet.read more. Let’s talk about them.

Current liabilities

These liabilities are often called short-term liabilities. These liabilities can be paid off within a year. Let’s see the items we can consider under short-term liabilities –

Let’s have a look at the format of current liabilities –

 M (in US $)N (in US $)
Accounts Payable1400025000
Current Taxes Payable170005000
Current Long-term Liabilities1000012000
Total Current Liabilities4100042000

Long-term liabilities

Long-term liabilities are also called non-current liabilities. These liabilities can be paid off over a long haul.

Let’s have a look at what items we can consider under long-term liabilities –

Here’s an example –

 M (in US $)N (in US $)
Accounts Payable1400025000
Current Taxes Payable170005000
Current Long-term Liabilities1000012000
Total Current Liabilities4100042000
Long term debtTerm DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability.read more109000108000
Provisions3000020000
Employee Benefits Liabilities2000025000
Total Long Term Liabilities159000153000
Total Liabilities200000195000

If we add the current liabilitiesThe Current LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.read more and long term liabilities, we would be able to get “total liabilities” in the balance sheet.

Why are liabilities not expenses?

Liabilities are often confused with expenses. But they are quite different.

Liabilities are the money owed by a business. For example, if a company takes a loan from a financial institution, the loan is a liability and not an expense.

On the other hand, the phone charges a company pays to connect with their prospective clients are expenses and not liabilities. Expenses are the on-going charges the company pays to enable revenue generation.

However, certain expenditures can be treated as a liability. For example, outstanding rent is treated as a liability. Why? Because unpaid rent denotes that space has been utilized for the year, but the actual money is yet to be paid. As the money for rent is yet to be paid, we will assume it to be “outstanding rent” and record it under the “liability” head of a balance sheet.

Leverage and liabilities

There’s a strange relationship of leverage with liabilities.

Let’s say that a company has taken a loan from the bank to acquire new assets. If a company uses liabilities to own assets, the company is said to be leveraged.

That’s why it’s said that a good proportion of debt and equity ratio is good for business. If the debt is too much, it will harm the company eventually. But if it can be done in the right proportion, it’s good for business. The ideal ratio would be 40% debt and 60% equity.

If the debt is more than 40%, the owner should reduce the debt.

Critical Differences Between Assets and Liabilities

Comparative Table

Basis for ComparisonAssetsLiabilities
1. Inherent meaningIt provides future benefits to a business.Liabilities are obligations to the business.
2. Depreciation They are depreciable.They are non-depreciable.
3. Increase in accountIf an asset is increased, it would be debited.If liability is increased, it would be credited.
4. Decrease in accountIf an asset is decreased, it would be credited.If liability is decreased, it would be debited.
5. TypesThey can be classified under many types – tangible-intangible, current-non-current, fictitious assets, etc.They can be classified under – current & long-term.
6. Cash flowGenerates cash inflow over the years;Flush out cash (cash outflow) over the years.
7. EquationAssets = Liabilities + Shareholders’ EquityLiabilities = Assets – Shareholders’ Equity
8. FormatWe present current assets first and then non-current assets.We present current liabilities first and then non-current liabilities.
9. Placement in the balance sheetThey are placed first.They are placed after “total assets” are calculated.

Assets vs. Liabilities Video

 

Conclusion

Both are part and parcel of business. Without creating assets, no business can perpetuate. At the same time, if the business doesn’t take any liability, then it will not be able to generate any leverage for itself.

If the assets of the business are appropriately utilized, and liabilities are taken only to acquire more assets, a business will thrive. But that doesn’t always happen because of the uncontrollable factors business faces.

That’s why, along with generating cash flow from the main business, organizations should invest in assets that can generate cash flow for them from various sources.

As for any individual, the secret to wealth is to create multiple streams of income; for organizations as well, various streams of income are necessary to fight the unprecedented events in the near future.

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This article has been a guide to Assets vs. Liabilities. Here we will go through a comparative analysis of assets and liabilities and would look at various aspects of them in length. You may also have a look at our other useful articles –

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  1. baoquan yang says

    Very good material

  2. Josia says

    Thanks for your brief lesson I have read, basically I have no or very little elementary knowledge in accounts, I believe through such lesson I am going to acquire something to apply in daily life.

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