Assets vs Liabilities

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

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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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 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 an extended period.

Let’s have a look at the items under “non-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
Investments 100000 125000
Equipment 111000 114000
Plant & Machinery 50000 35000
Total Fixed Assets 261000 274000
Total Assets 350000 360000

In the 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 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 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 specific type of assets like warrants, employee stock options, etc.
  • Fair value accounting 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 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 sheet. 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 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 –

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 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

  • Assets are something that will pay off the business for a short/long period. Liabilities, on the other hand, make the business obligated for a short/long period. 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 of acquiring 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.

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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Comments

  1. Avatarbaoquan yang says

    Very good material

  2. AvatarJosia says

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