An asset is an economic resource owned by an individual, corporation, or country. It can be anything that has economic value. Its owner may completely own it or have exclusive access to it. Cars, buildings, and cash or accounts receivable are some common examples of an asset. Let us take a deeper look at what is an asset, along with examples and types of assets.
What Is an Asset?
Anything that gives a current, potential, or future economic benefit can be classified as an asset. It is something that is owned by you, or you have an exclusive right over it, or something that is owed to you. A simple chair can be defined as an asset if it qualifies the above criteria. You own it, it is of value, and you can earn profit by selling it.
What Is an Asset? — Definition of Asset
The definition of an asset in personal finance is a resource owned by an entity that is of economic value to it. It promises economic benefit currently, in the future, or has the potential for it. Assets are a crucial element in the edifices of business establishments as well as non-profit organizations. They can be sold, bought, or exchanged. They also play pivotal roles in the functioning of an enterprise.
For example, a building is an asset that benefits its owners by giving them a space to operate their business. Its value may rise or fall according to the market. The owners may sell it in exchange for monetary gains.
What Is the Essence of an Asset?
According to The Financial Accounting Standards Board (FASB) Concept Statement 6, the essence of an asset is future economic gain (paragraphs 27 to 31). The asset serves its owners by being used to produce something, being used to settle liabilities, or by being exchanged for a sum of money. All economic resources have service potential. The biggest indicator of future economic gain being the essence of an asset is its market price. Anything that is bought and sold has the potential for future economic gain.
How are Assets Categorized?
Now that you understand what an asset is, let us look at the different classifications of assets. Though there are many ways to the classification of assets, they can be divided into two major groups: tangible assets and intangible assets. Tangible assets can be further divided into current and fixed assets.
Tangible Assets
Tangible assets are economic resources that have a physical shape and substance. Their value depends on their physical state. They need to be in useful physical condition to stay valuable. Depreciation is the method used to calculate the decline of the value of a tangible asset over time. Examples of tangible assets include buildings, cars, currencies, equipment, art collections, properties, and crops.
Intangible Assets
Economic resources that have no physical shape, presence, or substance are classified as intangible assets. For example, the goodwill of a company, copyrights, trademarks, permits, and intellectual property all fall under intangible assets. Since they don't have a physical form, it is very hard to evaluate their worth. The income approach is usually used to evaluate them. It includes the valuation of present cash flows and future cost-saving. Now let us look at the subcategories of tangible assets, i.e., current, and noncurrent assets.
Current Assets
Current assets are economic resources that can be readily sold and converted into cash. They are short-term in nature and expected to be converted to cash within a year. If they are not sold, they provide value by the way of consumption or usage in operations. Examples of current assets include cash, cash equivalents, liquid assets, inventory, and accounts receivable. They have high liquidity.
Fixed Assets
Fixed assets, also called noncurrent assets, or hard assets, are economic resources that will take a long time to be converted to cash. They are long-term in nature and low in liquidity. Any asset that cannot be converted to cash within a year of purchase can be classified as a fixed asset. Examples of fixed assets are land properties, buildings, cars, big machinery, and any asset that is not intended for sale within 12 months. Depreciation is the method used to evaluate the decrease in value of a fixed asset during its lifetime. The two most common ways to calculate depreciation are the straight-line method and the written down value method.
The former imposes a fixed amount on the asset for its useful life whereas the second one calculates a new amount for every accounting year. Other than the traditional classification, there are a few more ways to classify assets. Some other types of assets include:
Financial assets - When you invest in the assets of other institutions, it is considered a financial asset. For example, shares, bonds, debentures, etc. They offer opportunities to earn and create wealth for the investor.
Operating assets - Assets that are put to work on a regular basis to generate revenue are called operating assets. Examples of operating assets are machinery and licenses.
Non-operating assets - non-operating assets are resources that generate revenue, but on a day-to-day basis. A vacant piece of land can be classified as a non-operating asset.
Wasting asset - An asset that declines in value over time is called a wasting asset. You may maintain it well to make it last longer, but it will surely lose value over time. Examples include vehicles, electronic items, and machinery.
Relationship Between Assets, Liabilities, and Equity
Total assets = Liabilities + shareholder’s equity
A company's assets, liabilities, and equity share a close relationship. They reflect the firm's financial position. They appear together on the company's balance sheet, which gives a complete breakdown of the three.
Definitions
Assets are tangible or intangible items that hold value and are owned by the company.
Liabilities are the legal debts a business is liable to pay off a third party.
Equity is the debt-free valuation of assets. It is also the difference between assets and liabilities.
While assets represent a net gain in value, liabilities represent a net loss in value. Whereas equity is the true value of the assets after financial obligations are paid off. Thus, a company’s total assets are a sum of liabilities and equity.
Relationship
Together, they help represent the financial health of the company. The debt-to-equity ratio of a company should be lower than 1. A lower ratio indicates that the company has fewer or less value of debts to pay off. Whereas a higher ratio, especially one that is higher than 2, shows that the firm has more debt to pay and less value of debt-free assets. A firm that has collected too much debt signals troubled management or poor performance. This way, assets, liabilities, and equity help determine the financial health of a company and help investors make informed decisions.
Conclusion
An asset is one of the most important elements of a financial aspect of a company, individual, or country. Any resource that has current, potential, or future economic benefit can be classified as an asset. Assets can be broadly classified into tangible and intangible assets. Tangible assets can be further classified into fixed and current assets.
Assets, along with liabilities and equity help represent the financial strength of a company. Liabilities summed up with equity become the value of total assets. As an investor, you should look for companies that have lower debt and high equity, as it is representative of smooth management and a strong financial position.
FAQs
1. Which asset cannot be depreciated?
Land is one fixed asset that cannot be depreciated. It has an unlimited useful life. Depreciation is calculated based on the price and useful life of the asset and since a piece of land has an unlimited useful life, there is no depreciation for it.
2. Which asset is the most liquid?
Cash itself is the most liquid asset. An asset’s liquidity is based on how quickly it can be converted into cash. Since cash is already in the form it ought to be converted into, it is the most liquid asset.
3. What assets should I buy?
Paper stocks such as shares are considered the best investment options when it comes to buying assets. They represent equity i.e., ownership in a business, and are one of the most reliable ways to create income and wealth in the long run.
4. Is there a non-physical asset?
Yes, there are non-physical assets. They are called intangible assets as they don’t have a physical form. Examples of non-physical assets are the goodwill of a company, patents, copyrights, and intellectual property.