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The resources of a company are known as assets. In other words, everything that the company has ownership rights on is assets.
- accounts receivable
- prepaid insurance
- equipment and
are all examples of assets.
Asset subcategories include tangible and intangible items or entities that are valuable economically and owned by a company. Included intangible assets are brick and mortar buildings and other types of physical entities of a business.
- equipment and machinery
- The property, plant, and equipment
- motor vehicles
- leasehold improvements
are all examples of tangible assets. Intangible assets, on the other hand, are items representing money or value;
- accounts receivables
- contracts and
- certificates of deposit
are all examples of intangible assets.
From an accounting standpoint, an asset is a valuable item and a company is the owner of an asset. Any tangible or intangible item of value is an asset. Assets contribute to a company’s value addition and are crucial in terms of the success of a company.
The assets that a company owns are known as fixed assets. Fixed assets contribute to the income generation process of a company, but they are neither consumed nor held for the purpose of converting to cash. As items of fixed assets are tangible, substantial cash outlay is required for a protracted period of time. Fixed assets are tangible assets with a life span of at least one year and usually longer.
Fixed assets are acquired at cost and they are booked at cost as well. There are a few instances of incurring costs in addition to acquisition cost to ensure that the asset can be used. The acquisition cost of a fixed asset is all inclusive of any additional cost incurred.
Current assets are a balance sheet item. Current assets are those types of assets with a conversion time of approximately a year. Assets with a conversion time of over a year are apparently anything but liquid. Hence, they fall into the category of fixed assets.
- short-term investments
- accounts Receivable
- prepayments or prepaid expenses
represent current assets appearing on the balance sheet in order of fluidity; from the most fluid asset right down to the least fluid. Cash, for example, is the most fluid and prepayment being the least fluid.
Managing current assets is the basics of a successful business operation. Day-to-day vital functions of a business are reliant on current assets. Hence, companies are compelled to allocate huge amounts so that current assets are managed properly. Current assets are items that are completely consumed, sold, or converted into cash within a year or less.
Cash, for example, is a part-and-parcel of the treasury department of a company. The focus of the treasury department is on managing
- bank accounts
so on and so forth. Accounts receivable have two components, collection and credit control that manage accounts receivable as a whole. Inventory, on the other hand, is managed by purchasing, disbursement and valuation departments respectively.
Current assets are the lifeblood of a company. Inventory, for example, is a case-in-point of how crucial current assets are. Inventory is an asset that is the opening stock of a company that would be sold. The quick movement of inventory is substantially vital for the successful functioning of the company.
At the time of purchase of an asset valuation of the asset isn’t done based on how much revenue it would generate if it were to be sold. Rather a separate asset account is created and the asset is capitalized instead of being expensed. For the purpose of accounting, on each accounting period, the value of the fixed asset is partly charged to profit and this entire procedure is known as depreciation.
Due to depreciation, the value of an asset is reduced but more than that depreciation fundamentally follows a principle of accounting known as the matching principle. The matching principle can be defined as a principle of accounting that matches expenses to revenue that an expense helped generate. There are quite a few methods of calculating depreciation. Big corporations typically use any one of the methods as under:
- straight line
- declining or reducing a balance
- the sum of years’ digits
- double declining balance
Due to the huge cash outlay involving a purchase of fixed assets, a cost versus benefits analysis is done prior to acquiring fixed assets. The analysis aims at determining as accurately as possible the value addition during the useful life of the asset. The value addition should be in the form of generation of huge positive cash flow in comparison with the cash outlay at the time of purchase of an asset.
Repairing assets periodically are necessary. If the useful life of the asset increases after the repair then the repair cost ought to be capitalized. On the other hand, if the useful life of an asset remains unchanged after the repair then the repair cost usually is expensed. Repairs that actually extend the life of an asset would add value to the asset hence capitalized. Conversely, repairs that are for the purpose of maintenance of assets would be expensed.
The value of an asset is represented by capitalizing the initial costs which are:
- the price of the asset
- delivery charges
- installation and associated setup charge.
While an asset has useful life the costs that would be capitalized are:
- repair or replacement that would result in the extension of the life of an asset
- adding to an asset significantly
- any sort of service or maintenance that would result in the asset’s extended life
Grouping of assets is done based on fluidity for two reasons; one it’s practical and the other is that a company would thrive on fluidity. Fluidity essentially means the conversion of assets into cash with ease. Hence among all types of assets, cash is an asset that does not need further conversion, unlike other asset types.
From an accounting perspective, when a company is obligated to transfer something as valuable as an asset to another party it is known as the liability. On the balance sheet, a liability could either be a debt with legal ramification or it could be an obligation that is estimated also known as an accrual.
Companies borrowing from financial institutions; banks, for example, money lenders, individuals or groups are commonplace. Hence, debt from a financial standpoint is always a consideration. Any company at any juncture could own assets, the owners would have made investments in the company and the company would owe creditors and non-owners. Liabilities are a reflection of the degree to which the company is indebted to creditors.
Liability is considered a source of funding for a company. The company, in turn, would have an impetus in terms of purchasing power for enhancement of the business in general. More specifically the company would be able to purchase fixed assets, inventory, pay creditors so on and so forth.
Companies are contractually obligated to honor their liabilities failing which they run the risk of facing legal suits. A liability contract could either be very simple or complex. Not all but a few creditors could be requesting that the debtor company pay interest in addition to repaying the principal on its debt. They could also request that the debtor company have appropriate accounting ratios in place; a prescribed cash balance and net worth. There might be other creditors who may simply require that the principal amount is repaid as scheduled.
Under current liabilities accounts, payable is a representation of the amount due to creditors within a year for operating expenses. There are instances though of a current portion of long-term debt due for payment in less than a year being included in current liabilities. Management of current liabilities is crucial to the cash flow procedure which makes the company far more viable in terms of its operations. Current liabilities management is vital to prevent working capital issues leading to failures in operations. Current assets deducted from current liabilities are working capital. Current liabilities are offset using current assets; hence, both have to be managed in combination.
- Accounts Payable
- Notes Payable
- Short-term portion of long-term debts
- Income Tax Payable
- Wages Payable
- Accruals or accrued expenses
are a few of the current liabilities typically appearing on the balance sheet.
Accounts payable essentially are trade debts usually due within a month. The terms and conditions of trade debts can be negotiated beyond thirty days which is sufficient time to improve cash flow as payment is deferred for as long as feasible.
Notes payable are debt with a payback time period of more than two and less than ten years. Current liabilities are typically due in less than a year. Any amount that is due after a year falls under long-term debt on the balance sheet. A substantial amount of long-term debt of a company is paid back over several years. The amount of long-term debt is due every year and would be considered as current liabilities with the heading “current portion of long-term debt” on the balance sheet. If the amount that is currently due to isn’t paid on time then the company would be defaulting on a loan. As a result, the consequences would be negative for the company.
Income tax payable is the tax amount due to the government and is calculated on the taxable amount which is based on earning of accounting profit. Wages payable represents amounts owed to employees. Accrued expenses represent operating expenses incurred but not paid for. Accrued expenses may be analyzed as the flip side of prepaid expenses. While prepaid expenses represent the amount for services/goods not yet received, accrued expenditure represents services used/goods received but not yet paid for.
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