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 in nature, 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.
In this article, we will go through a comparative analysis of both components and would look at various aspects of them in length.
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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 provides you 5 years of convenience so that you can keep and store important 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 on their money every year. Investments are assets to the organizations since these investments are able to 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” –
- Cash & Cash Equivalents
- Short-term investments
- Inventories
- Trade & Other Receivables
- Prepayments & Accrued Income
- Derivative Assets
- Current Income Tax Assets
- Assets Held for Sale
- Foreign Currency
- Prepaid Expenses
Have a look at the example of current assets –
| M (in US $) | N (in US $) | |
| Cash | 12000 | 15000 |
| Cash Equivalent | 17000 | 20000 |
| Accounts Receivable | 42000 | 35000 |
| Inventories | 18000 | 16000 |
| Total Current Assets | 89000 | 86000 |
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 a long period of time.
Let’s have a look at the items under “non-current assets” –
- Property, plant, and equipment
- Goodwill
- Intangible assets
- Investments in associates & joint ventures
- Financial assets
- Employee benefits assets
- Deferred tax assets
| M (in US $) | N (in US $) | |
| Cash | 12000 | 15000 |
| Cash Equivalent | 17000 | 20000 |
| Accounts Receivable | 42000 | 35000 |
| Inventories | 18000 | 16000 |
| Total Current Assets | 89000 | 86000 |
| Investments | 100000 | 125000 |
| Equipment | 111000 | 114000 |
| Plant & Machinery | 50000 | 35000 |
| Total Fixed Assets | 261000 | 274000 |
| Total Assets | 350000 | 360000 |
In Balance Sheet, 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 understand the meaning of the word “fictitious”. “Fictitious” means “fake” or “not real”.
That means fictitious assets are fake assets. These are actually not assets but losses and/or expenses. But due to some unavoidable circumstances, these losses and/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 –
- Preliminary expenses
- Loss on the issue of debentures
- Promotional expenses
- Discount allowed on the issue of shares
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 assets 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 analysis, capital budgeting, 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 –
- Absolute value method: Under the absolute value method, the present value of assets should be ascertained. There are two models organizations always use – DCF Valuation method (for multi-periods) and Gordon model (for a single period).
- Relative value method: Under the relative value method the other similar assets are compared and then the value of the assets is determined.
- Option pricing model: This model is used for a certain type of assets like warrants, employee stock options, etc.
- Fair value method: As per US GAAP (FAS 157), the assets should be purchased or sold off in their fair value only.
What are Liabilities?
Liabilities are something that an organization is obligated to. 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 and then when the deadline arrives they pay back their shareholders and debenture holders.
Types of liabilities
Let’s see two main types of liabilities. 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 –
- Financial Debt (Short term)
- Trade & Other Payables
- Provisions
- Accruals & Deferred Revenue Income
- Current Income Tax Liabilities
- Derivative Liabilities
- Accounts Payable
- Sales Taxes Payable
- Interests Payable
- Short Term Loan
- Current maturities of long-term debt
- Customer deposits in advance
- Liabilities directly associated with assets held for sale
Let’s have a look at the format of current liabilities –
| M (in US $) | N (in US $) | |
| Accounts Payable | 14000 | 25000 |
| Current Taxes Payable | 17000 | 5000 |
| Current Long-term Liabilities | 10000 | 12000 |
| Total Current Liabilities | 41000 | 42000 |
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 –
- Financial Debt (Long term)
- Provisions
- Employee Benefits Liabilities
- Deferred Tax Liabilities
- Other Payable
Here’s an example –
| M (in US $) | N (in US $) | |
| Accounts Payable | 14000 | 25000 |
| Current Taxes Payable | 17000 | 5000 |
| Current Long-term Liabilities | 10000 | 12000 |
| Total Current Liabilities | 41000 | 42000 |
| Long term debt | 109000 | 108000 |
| Provisions | 30000 | 20000 |
| Employee Benefits Liabilities | 20000 | 25000 |
| Total Long Term Liabilities | 159000 | 153000 |
| Total Liabilities | 200000 | 195000 |
If we add the current liabilities 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 outstanding 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 would 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.
Do have a look at the following articles –
- What is Gearing Ratio Formula?
- Examples of Long-term Liability
- Joint Venture JV Examples
- Tangible Assets Examples
- Capitalization Ratio Examples
- Capital Gearing Ratio Examples
Key Differences Between Assets and Liabilities
- Assets are something that will pay off the business for a short/long period of time. Liabilities, on the other hand, make the business obligated for a short/long period of time. If obligations are deliberately taken for acquiring assets, then the liabilities create leverage for business.
- Assets are debited when increased and credited when decreased. Liabilities, on the other hand, are credited when increased and debited when decreased.
- All fixed assets are depreciated, meaning they all have wear & tear and over the years these fixed assets lose their value after their lifetime expires. The only land is a non-current asset that doesn’t get depreciated. Liabilities, on the other hand, can’t be depreciated, but they are paid off within a short/long period of time.
- Assets help generate cash flow for businesses. On the other hand, liabilities are reasons for cash outflow since they must be paid off (however, there is a big difference between liabilities and expenses).
- Assets are acquired with the motive of expanding the business. Liabilities are taken with the hope to acquire more assets so that the business becomes free of most of the liabilities in the future.
Comparative Table
| Basis for Comparison | Assets | Liabilities |
| 1. Inherent meaning | It provides future benefits to a business. | Liabilities are obligations to the business. |
| 2. Depreciation | They are depreciable. | They are non-depreciable. |
| 3. Increase in account | If an asset is increased, it would be debited. | If liability is increased, it would be credited. |
| 4. Decrease in account | If an asset is decreased, it would be credited. | If liability is decreased, it would be debited. |
| 5. Types | They can be classified under many types – tangible-intangible, current-non-current, fictitious assets, etc. | They can be classified under – current & long-term. |
| 6. Cash flow | Generates cash inflow over the years. | Flush out cash (cash outflow) over the years. |
| 7. Equation | Assets = Liabilities + Shareholders’ Equity | Liabilities = Assets – Shareholders’ Equity |
| 8. Format | We present current assets first and then non-current assets. | We present current liabilities first and then non-current liabilities. |
| 9. Placement in the balance sheet | They are placed first. | They are placed after “total assets” are calculated. |
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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 create any leverage for itself.
If the assets of the business are properly 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, multiple streams of income are necessary so as to fight the unprecedented events in the near future.
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