Every business owns and controls assets - valuable resources that produce either current or expected future economic benefits. Reported on a company’s balance sheet along with liabilities and equity, assets are an important component of the main accounting equation. In this article, we are going to explain what is a business asset exactly and how assets can be classified.
Highlights/ Key Takeaways
- Business assets are economic resources that a company can use to generate value, - for example, to increase sales or reduce production costs.
- Business assets can be either tangible (for example, a piece of property or equipment) or intangible (for example, intellectual property).
- Assets can also be classified into current or non-current, as well as operating or non-operating.
- The historical cost of business assets is listed on the left side of a balance sheet, starting with the most liquid ones. Asset depreciation or amortization expenses are also included.
What Is a Business Asset?
IFRS defines an asset as “a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.”
Describing what are assets in simple words, the term “asset” refers to anything that a company owns, controls, or can use to produce income or reduce expenses. Cash, marketable securities, patents, trademarks, buildings, land, and machinery are all examples of assets.
Along with equity and liabilities, assets are one of the three pillars of the main business accounting equation. Business assets are listed on the left side of a balance sheet, with liabilities listed on the right. The asset list starts with the most liquid items at the top of the financial statement, with the least liquid ones at the bottom.
“The term “asset” refers to anything that a company owns, controls, or can use to produce income or reduce expenses. Cash, marketable securities, patents, trademarks, buildings, land, and machinery are all examples of assets.”
Key Properties of Assets
Any business asset, tangible or intangible, must have the three following properties:
- Ownership. First of all, a business must have control or ownership of the asset. This means that the company can convert the asset into cash or cash equivalent when needed, - even though this might not always apply to right-of-use assets or lease agreements.
- Economic value. Secondly, an asset must provide economic value, meaning it can be sold or converted to cash or cash equivalent in other ways. For right-of-use assets and lease agreements, the economic value comes from the support they provide for business growth and production.
- Resources. Lastly, an asset must be a resource, meaning that it can provide current or future economic benefit. Most of the time, this means that the asset can produce future positive cash flows.
How Business Assets Work
Business assets support a company’s ability to generate cash and expand. Assets can be categorized based on specific characteristics, such as their business purpose or how easily they can be converted into cash.
Accountants itemize assets and liabilities on a balance sheet in order to help management assess a company’s risk and solvency. The balance sheet is then included in the company’s annual report. This information is used by lenders to determine whether to extend a loan to a company. Business investors also review business asset lists when deciding on whether to invest in a particular company or not.
When learning what is a business asset, note that the balance sheet lists business assets at historical cost rather than the market value, starting with more liquid items. Liquid assets can be quickly converted to cash when needed, meaning they can be bought or sold in the market with no effect on the price.
It is also worth noting that most business assets can be written off as an expense on the income statement. This can be done by either representing an asset as a single large expense at the time of purchase or by depreciating it over its useful lifetime.
Types of Business Assets
Broad asset types include current, non-current, tangible, intangible, operating, and non-operating assets. Some of these types are mutually exclusive: for example, an asset can be either current or non-current. At the same time, others are not mutually exclusive: for instance, an operating asset can be current or non-current, tangible or intangible.
- Current assets. Current assets in business can be used up or converted into cash within one fiscal year. Cash and cash equivalents are current assets; so are marketable securities like bonds and stocks, accounts receivable, and business inventory. While cash is easy to value, accountants can periodically reassess the value of inventory and accounts receivable.
- Non-current assets. Also known as fixed assets, non-current assets are longer-term assets that a business can continue to use for more than one year, - for example, equipment, plants, and buildings. As fixed assets age and lose their value, accountants adjust their recorded value through depreciation.
- Tangible assets. Tangible or fixed assets in business are physical in nature and can be touched by hand. Both current and non-current assets can be tangible, including cash, property, equipment, office supplies, and more.
- Intangible assets. Intangible assets have monetary value but are not physical in nature, meaning you cannot touch them. For example, intellectual property, patents, stocks, and royalties are intangible. Some intangible assets, like intellectual property, do not have an obvious monetary value either.
- Operating assets. Operating assets are necessary for running a business. For instance, if you own an Italian restaurant selling pizza, a pizza oven would be an operating asset.
- Non-operating assets. Non-operating assets aren’t used on a day-to-day basis but they are necessary to keep a company financially stable. These could include marketable securities, short-term investments, land not currently used, and loans receivable.
Examples of Business Assets
The exact asset mix of a business can vary depending on the industry it is in, how long it has been in operation, and the company’s asset allocation strategy. For example, the assets of a real estate development company will include buildings and likely other financial assets like commodities and stock. At the same time, assets of a home daycare business will include the living space, playground equipment, and toys.
However, most assets are common among all types of businesses. These can include the following business asset examples:
- Stocks
- Cash
- Office supplies
- Patents and trademarks
- Inventory
- Real estate
- Short-term investments
- Long-term investments
- Factory equipment
- Loans
How Business Assets Are Classified
Business assets can be classified according to their convertibility, physicality, and usage. Each classification includes two asset types or categories, - for example, the current and non-current assets described above fall under the “convertibility” classification. Similarly, tangible and intangible assets belong to the “physicality” classification, while operating and non-operating assets belong to the “usage” classification.
A single asset will typically fall within only one category per classification: for example, a particular asset can be described as current, tangible, and non-operating.
Asset Classification by Convertibility
The term “convertibility” refers to how easy it is to convert an asset into money. Based on its convertibility, an asset can be described as either current or non-current, with current assets listed on a balance sheet first.
Recall that current assets are short-term assets that can be converted into cash within a year, - for example, cash and equivalents, inventory, marketable securities, and more. Non-current assets like real estate or long-term investments can’t be converted into cash as quickly. However, they are important to businesses, as they can provide future economic benefits.
Asset Classification by Physicality
Assets can also be categorized based on their physicality, meaning whether or not they physically exist.
Tangible assets are physical and can be touched by hand: think equipment, property, cash, raw materials, tools, office supplies, and so on.
Intangible assets are more abstract in nature and cannot be touched. However, they can still bring value to your company, - for example, intellectual property and patents can be used to support business expansion.
Asset Classification by Usage
Finally, assets can be categorized by usage or purpose, meaning how exactly a company uses them.
Operating assets are used regularly to achieve the primary purpose of the business. For example, vehicles belonging to a car dealership would be considered operating assets.
Non-operating assets aren’t used as regularly and serve secondary business purposes. For instance, a company’s short-term investments and marketable securities can be classified as non-operating assets, as they serve the purpose of keeping the business financially stable rather than simply keeping it running.
Why Is the Classification of Business Assets Important?
Properly listing assets on a balance sheet is critical to accurately represent the company’s financial health. As such, properly classifying business assets is of the utmost importance. Listing assets as current or non-current, tangible or intangible, operating or non-operating can help to understand how each asset contributes to the overall revenue and what percentage of this revenue comes from different types of business activities.
Accounting for Business Assets
In accounting, business assets often need to be valuated to determine their fair market values. Tangible assets can also be depreciated, while intangible assets - amortized over their useful lifetime.
Valuing Business Assets
The value of a particular business asset can vary and change over time. Many tangible, current assets like vehicles, computers, and equipment tend to age and gradually lose their value. They may even become obsolete as newer, more advanced technologies are developed.
When companies want to substantiate depreciation deductions or use an asset as collateral, they can get them valued by a specialized appraiser. For intangible assets without an obvious monetary value (for example, intellectual property), the value can be estimated by looking at the value of similar products on the market. Alternatively, you can find their value by subtracting a company’s liabilities from its assets. Then, you would need to subtract the resulting number from the asset’s market value.
Depreciation of Tangible Business Assets
Depreciation is the process of spreading the cost of a fixed or tangible asset throughout its useful life. The depreciation expense can be calculated by subtracting the salvage or resale value of an asset from its original cost. This difference is then divided by the useful life of the asset. This gradual reduction in the cost of the asset is the amount that a company can write off each year under depreciation.
Depreciation Formula
Depreciation = (Original Cost - Salvage or Resale Value) / Useful Life
Depreciation Example
Suppose you purchase a piece of equipment for $50,000. It has a useful life of 10 years and a salvage value of $5,000. In that case, the depreciation expense can then be calculated as:
($50,000 - $5,000) / 10 years = $4,500 / year
This means that the business would be able to write off $4,500 per year as the depreciation expense associated with the piece of equipment.
“Depreciation is the process of spreading the cost of a fixed or tangible asset throughout its useful life.”
Amortization of Intangible Business Assets
Just like tangible assets can be depreciated, intangible assets can be amortized. Companies can divide the value of current, intangible assets over their useful life. This can help the management to measure the revenue generated by their patents, copyrights, customer satisfaction, or employee morale.
Amortization can be calculated similarly to depreciation: the original cost of the asset minus its residual value at the end of its useful life, all divided by the number of years the asset is in use.
Amortization Formula
Amortization = (Original Cost - Residual Value) / Useful Life
Amortization Example
Company ABC hires 10 employees to work on a new project over the next five years. The company spends $500,000 in initial salaries and expects the team to earn $200,000 in business profit over five years. The amortization can then be calculated as:
Amortization = ($500,000 - $200,000) / 5 years = $60,000 / year
This means that the accounting team can report $60,000 in amortization expenses every year.
How to Record Business Assets on the Balance Sheet
Accepted accounting principles require that business assets are properly classified and recorded on a balance sheet. Luckily, recording business assets is not difficult, - simply follow these steps:
Step One: Make a List of All Business Assets
Think about all the assets belonging to your business and write them down. Your list can include both tangible and intangible assets, current and longer-term. You can ask your coworkers or employees to review the list and see whether you have missed something.
Your list of assets can look something like this:
Assets:
- Patent
- Copyright
- Inventory
- Brand
- Customer relationships
- Domain name
- Accounts receivable
- Computers
- Intellectual property
- Desks
- Chairs
- Cash
- Telephones
- Photocopy machine
- Short-term investments
- Prepaid expenses
- Transport vehicles
- Three office buildings
- Manufacturing equipment
Step Two: Divide Assets into Current and Non-Current
Based on the definition of current and non-current assets, separate the list into two groups. If an asset is likely to provide revenue within one fiscal year, place it into the current group. Otherwise, place it under non-current assets.
Your list of assets will now look like this:
Current Assets:
- Inventory
- Accounts receivable
- Cash
- Short-term investments
- Prepaid expenses
Non-Current Assets:
- Patent
- Copyright
- Brand
- Customer relationships
- Domain name
- Computers
- Intellectual property
- Desks
- Chairs
- Telephones
- Photocopy machine
- Short-term investments
- Transport vehicles
- Three office buildings
- Manufacturing equipment
Step Three: Add the Total Value of All Business Assets
Next, add up the total value of current and non-current assets your company has. If you have trouble determining the value of a particular asset, you might want to ask a senior financial professional at the company or consult past financial reports.
Suppose you determine that the company has $4,000,000 in non-current assets and $700,000 in current assets. The total asset value will then be:
Total Assets = Current Assets + Non-Current Assets
Total Assets = $4,000,000 + $700,000 = $4,700,000
Review Calculation and Check for Accuracy
To make sure that you have recorded all the company’s assets correctly, you can use the following formula:
Total Liabilities + Equity = Total Assets
Here, Total Liabilities are the total amount of money owed by a business. Equity is its capital or net worth. If your company’s Liabilities and Equity add up to the value of the Total Assets you’ve just calculated, you have recorded all the assets properly!
For example, if a company has $2,700,000 in liabilities and $2,000,000 in equity, the calculation will look like this:
Total Liabilities + Equity = $4,700,000
$2,700,000 + $2,000,000 = $4,700,000
$4,700,000 = $4,700,000
Since the sum of Total Liabilities and Equity equals Total Assets, you have entered all the asset information correctly.
Final Word
Business assets are valuable resources owned and controlled by a company, which have the potential to produce economic benefits. Now, that you understand what is a business asset, properly classifying and recording your company’s assets on a balance sheet should not be a problem. This information can then be used by the management and external stakeholders to accurately evaluate the financial position of your company.
