Understanding the Different Types of Assets and Liabilities
Assets and liabilities play an essential role in ensuring the profitability and long-term sustainability of a business. The key to achieving these goals depends on how the company effectively manages its assets and liabilities. Therefore, it is crucial to understand each of their classifications to manage company assets and liabilities properly.
This article discusses the different types of assets and liabilities. We aim to help you understand their classification and how they work.
Classifications of Assets and Liabilities
The primary difference between assets and liabilities is whether they lead to inflow or outflow of resources. Assets are resources the company owns and controls. They provide an inflow of economic benefits. Meanwhile, liabilities give rise to obligations, and its payment will lead to an outflow of monetary benefits.
Assets are classified into current assets, long-term investments, property, plant and equipment, and intangibles. On the other hand, liabilities are classified as current liabilities and long term liabilities.
Current assets are cash and other assets that are easily convertible into cash. Further, these assets will be used, consumed, or exhausted less than one year from the reporting date. Items under current assets are usually the first items to appear in the company’s balance sheet.
Current assets are the items the company uses to fund daily activities. Additionally, they also pay for usual and ongoing operating expenses. Existing Assets include cash, cash equivalents, inventory, receivables, supplies, prepaid expenses, and marketable securities.
Long Term Investments
Long term investments are company investments in stocks, bonds, real estate, and more. We call these investments long term because the company expects to hold them for more than one year. Unlike current assets, these are not expected to be converted into cash within the year.
An example of long-term investment is an investment in an associate. This is where the company purchases at 20% to 50% of another company’s ownership. Companies invest in investment in associates to receive a portion of the profits of the other company. Additionally, this also to gain significant influence over the latter company.
Further, if the company purchases more than 50% of another company’s ownership, that creates a parent-subsidiary relationship between the companies. Aside from benefiting from a share in profit, investment in associates also controls the parent or acquiring party. Thus the company can make significant decisions over the latter company.
The property, Plant, and Equipment (PPE)
Property, plant, and equipment are physical assets like furniture, land, machinery, and buildings. The company holds these properties for use in the business and not for sale. These items are usually precious and not easily convertible into cash.
Moreover, PPEs have their contra account to capture accumulated depreciation. This is because these properties are held for such a long time; they accumulate wear and tear through usage and time passage. Accumulated depreciation is deducted from the recorded cost of the PPE to reflect its estimated current value.
Intangible assets are non-monetary resources owned and controlled by the company with no physicality. They have value, but they cannot be touched or seen. Examples of intangible assets include patents, trademarks, copyrights, and software.
Businesses can create or acquire intangibles. Internally generated intangibles are not recognized and are thus not reflected in the balance sheet. However, when the company purchases intangibles, we recognize them initially at their acquisition cost.
Current liabilities are those business expenses that are payable within the year. Further, these are short-term obligations due within one year. Examples of current liabilities include accounts payable, notes payable, salaries payable, and obligations maturing in a year.
The company usually settles these items through current assets. Liquidity measures the company’s ability to pay its current liabilities using current assets. Having good liquidity means that you can easily pay your obligations without compromising your operations.
Long Term Liabilities
Long term liabilities are obligations that would mature for more than one year. Examples of long-term obligations are deferred tax liability, mortgages, car payments, and other long-term loans for machinery and equipment.
Long term liabilities usually finance big projects. For example, the company could be planning for an expansion, and it does not have enough funds. Companies usually take on long term liabilities to pay for the expenses of such expansion.
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