In this video you'll discover what Assets mean in accounting.
I'm going to break down the definition for you and take you
through some common types of Asset that are worth knowing about.
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Hey guys welcome to Accounting Stuff.
I'm James and in this video we're going to explore what
Assets mean in accounting. Before we dive into the good stuff,
I just want to make you aware that this video is part of a series that I've
created on Accounting Basics. If you missed any of the others
I'll pop a link to them up here and down in the description.
That will start you off at video number 1. I put our new content every week on
this channel so subscribe and hit the bell to be notified when
the next video is out.
Right… Assets...
What are assets? Assets of one of the three pillars of
the Accounting Equation alongside liabilities and equity.
They're hugely important because they are what businesses
use to operate and generate a profit. In this video I'll break down the
accounting definition of assets for you and take you through some of the common
types that exist in most businesses. We accountants we like to split assets
apart into different categories like current, non-current,
tangible or intangible. Don't forget to watch this video
through until the end because you'll discover what
all of these terms mean. Let's go…
I think most of us have kind of a preconceived idea of what an asset is.
We think of an asset as something that we own that's useful or has value.
Something along those lines… And that's not far from the truth.
Although the definition of assets in accounting is
a bit more specific.
Assets are probable future economic benefits obtained
or controlled by a particular entity as the result of past transactions
or events.
Say what? I know, what on earth does that mean?
Let's break the definition down and try to make some sense of it.
The first word that stands out to me is ‘probable’.
Assets are probable
future economic benefits.
The word ‘probable’ carries with it
a degree of uncertainty and I want to emphasise this because
I think that often we take numbers for granted.
Without questioning them. The reality is that the future is
uncertain and a lot of the time we accountants have to make estimates.
Let me give you an example… If you're running your business
and you've got ten clients who all owe you money.
Can you say hand on heart that
you'll receive back every penny?
It's not uncommon for customers
to go bankrupt or to dispute invoices after the work is done.
So what accountants do in these situations is make an allowance for
doubtful debts.
We estimate what might not be
recovered and expense it to provide for situations where there's uncertainty.
And that brings me on to the next part of the definition…
Assets are probable
future economic benefits.
What are future economic benefits?
These are the things that bring
value to you or your business either directly or indirectly.
Valuing assets based on future economic benefit means that we
can't simply hold them in the books the value that they originally cost us.
Imagine you buy a laptop today and you plan on keeping it and
using it entirely for work.
Will that same laptop carry the
same future economic benefit in five years time?
Probably not. It might well
have cacked it by then and not be worth anything anymore.
It can be hard to measure the lifespan of a laptop so instead we assume
that all laptops have a useful economic life of say…
Five years.
Useful economic life is a term that you'll
hear often when talking about assets. It's how long an asset will remain
useful to you and it's different to an asset's actual life because useful
economic life is an estimate.
So if that laptop cost you $1000 today
and we assumed a useful economic life of five years then we would depreciate
or reduce its value by $200 a year. For the next five years until it's worth
nothing at all.
Is this an exact science?
No. Clearly not.
But estimates like this are used every day to simplify scenarios and help
accountants value assets.
Lastly I want to bring your attention to
another part of the definition…
Assets are probable future
economic benefits obtained or controlled by a particular entity
as the result of past transactions or events.
Obtained or controlled.
This highlights
another important concept that we use in accounting
called ‘substance over form’. This means that when preparing financial
statements we prioritise the economic substance of transactions over their legal form.
An example of this is when a business rents a building for long period of time.
Say sixty years and that building’s remaining useful economic life
is sixty-five years.
Although the business is considered
a lessee and technically doesn't own the building.
The economic reality of the situation is that basically they do…
Make sense?
Because they have the right to use it for the majority of its remaining useful
economic life.
Following this principle of substance over form,
we can account for this building as an asset even though legally it isn’t.
That has big implications for the accounting and tax treatment
of the building.
Now I'm oversimplifying the situation.
There are a few other factors to consider when making this call,
but that's the gist of it. Okay so now we know what an asset is
let's run through some examples of common assets that you should know about.
But first, and bear with me here… a balance sheet is a snapshot of a
business's assets liabilities and equity at a single point in time.
In the asset section of a balance sheet, we list out all of the different types of asset
that a business owns or controls.
These assets are often arranged in order of liquidity.
But what is liquidity?
You can think of it as how quickly you can turn an asset into cash.
And following that vein of thought, assets in the balance sheet can be
divided into two distinct categories.
Current assets and non current assets.
Current assets are the ones that we can convert into cash in a short period
of time, typically within a year.
The three types of current asset
that show up most often are cash, accounts receivable and inventory.
Inventory is your physical stock, or the goods that you intend to sell
to make a profit. When your business sells inventory,
your customers owe you money which we call accounts receivable.
And when your customers actually pay you, your accounts receivable
turn into cash.
The most liquid asset of them all.
Other current assets include
prepayments and short-term investments.
You can think of prepayments as situations when you're paying for
something in advance. Rent is a good example because most
of us pay rent at the start of the month.
At the moment that rental payment is made
we need to recognise a prepayment as an asset in a balance sheet.
It's an asset even
though we aren't going to convert it into cash because
we're going to get some of that sweet sweet future economic benefit
out of it. Remember the definition?
Not all assets convert into cash.
Short-term investments can be made
when your business has cash to spare.
You might choose to put some of
that money to work by investing it in stocks and shares.
This investment is considered
to be a short-term investment or
current asset if you're in it for the short game and you plan to sell those
stocks or shares within a year's time. However if you want to hold on to them
for longer than a year they become Non current assets instead.
Non current assets
are long-term assets that are used in
operations to generate profits, and that can't easily be converted into cash.
There are three main categories of non-current asset.
The first which we touched
on a moment ago are
long-term investments.
These are the investments that we plan
to hold onto for longer than a year.
The other two categories of
non current assets are tangible or intangible assets.
Tangible, or fixed assets are the ones that have an actual physical presence.
You can actually touch them.
The most common types are
Land and buildings, or PPE. Which stands for
property plant and equipment.
These include things like
furniture, machinery
and cars.
But not all assets have a physical presence.
We call those that don't
intangible assets.
Intangible assets include things
like intellectual property, patents,
royalty rights, trademarks
and copyright.
If you're a photographer then you
might own the royalty rights to some of your own photos.
If a company wants to use one of your images for their website or blog
they should pay you a royalty fee to recognise your work.
So if this intellectual property that you own is bringing you
probable future economic benefit.
It should be an asset right?
The answer is sometimes…
The thing with intangible assets is that they can be very difficult to value.
How can you calculate the future economic value of your
own licensed photos?
You can't really.
So most of the time,
businesses don't capitalise intangible assets that
they've generated internally. What does capitalise mean?
When we capitalise something, we record it as an asset
in the balance sheet as opposed to expensing it in the income statement.
We only capitalise intangible assets that we've purchased from someone else
and these are held at the cost value that we paid for those assets,
or a lower amount because we amortise intangible assets to
decrease their value over time. Much like we depreciate fixed assets.
An intangible asset that doesn’t fit into the category of intellectual
property is goodwill.
Goodwill is the amount that one
company is prepared to pay for another
over and above the fair value of its net assets.
When Facebook bought Instagram back in 2012 for something stupid
like a billion dollars. Were Instagram’s net assets at the time
worth that much?
Not by a long shot.
The majority of that purchase
was for goodwill.
That's the premium that Facebook were
happy to pay for Instagram’s brand and potential future earnings,
over and above the fair value of their net assets.
Thanks for watching!
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As always if you've got any questions
let me know down below in the comments.
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maybe if you're feeling generous…You could send some of
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It's all good… Fire away.
As always there are new videos every week here on Accounting Stuff.
See you next time!
It's not cacked it yet,
although I did drop it whilst trying to put it in the bin.
Sorry laptop didn't mean to hurt you…
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