Assets vs Liabilities

Assets vs Liabilities explain the differences between the main components of a business. The former is anything owned by the company to provide economic benefits in the future. In contrast, liabilities are something that the company is obliged to pay it off in the future. Though these two elements are different, the purpose of both of them is to increase the lifespan of the business.

According to accounting standards, assets provide future benefits to the business. That’s why business consultants encourage businesses to build assets and reduce expenses. On the other hand, Liabilities are something that you’re obligated to pay off in the near or distant future. Liabilities are formed because you now receive a service/product to pay off later.

• As per accounting standards, assets enable future advantages to the business. Therefore, business consultants prefer to create business assets and reduce expenses. On the other hand, liabilities refer to the obligation to pay off soon or in the future. Therefore, liabilities are formed because one may receive a service/product which is later to be paid.
• Current, non-current, tangible, intangible, and fictitious assets are current assets.
• Current liabilities and long-term liabilities are the types of liabilities.

Both are part and parcel of business. Without creating assets, no business can perpetuate. At the same time, if the business doesn’t take any liability, then it will not be able to generate any leverage for itself.

If the business assets are appropriately utilized and liabilities are taken only to acquire more assets, a business will thrive. But that doesn’t always happen because of the uncontrollable factors business faces.

That’s why, along with generating cash flow from the main business, organizations should invest in assets that can generate cash flow for them from various sources.

As for any individual, the secret to wealth is to create multiple streams of income; for organizations as well, various streams of income are necessary to fight unprecedented events shortly.

What are Assets?

Assets are something that keeps paying you for year/s. For example, let’s say that you have purchased an almirah for your business. It has a lifetime value of 5 years. That means purchasing the almirah allows you to get paid for the next five years from now.

Some assets offer you direct cash inflow, and some provide you in kind. The almirah example gives you five years of convenience to keep and store relevant documents.

Now let’s talk about investments. Organizations often invest a lot of money into meaningful equities, bonds, and other investment instruments. And as a result, they get interested in their money every year. Investments are assets to the organizations since these investments can create direct cash flows.

What are Liabilities?

Liabilities are something that an organization is obligated to pay. For example, if ABC Company takes a loan from a bank, the loan would be ABC Company’s liability.

But why do organizations get involved in liabilities? They go to the shareholders or sell the bonds to individuals to pump in more money. Who would like to get into obligations? The straight answer is often, organizations run out of money, and they need external assistance to keep moving forward.

The organizations that collect money from shareholders or debenture holders invest the money into new projects or expansion plans. Then when the deadline arrives, they pay back their shareholders and debenture holders.

Types of assets

In this section, we will talk about different types of assets.

Current Assets

Current assets are those assets that can convert into liquidity within a year. In the balance sheet, current assets are placed first.

Here’re the items that we can consider under “current assets” –

• Cash Equivalent Cash & Cash Equivalents
• Short-term investments
• Inventories
• Trade & Other Receivables
• Prepayments & Accrued Income
• Derivative Assets
• Current Income Tax Assets
• Assets Held for Sale
• Foreign Currency
• Prepaid Expenses

Have a look at the example of current assets –

Non-current assets

These assets are also called “fixed assets.” These assets can’t be converted into cash immediately, but they benefit the owner for an extended period.

Let’s have a look at the items under “non-current assets” –

• Property, plant, and equipment
• Goodwill
• Intangible assets
• Investments in associates & joint ventures
• Financial assets
• Employee benefits assets
• Deferred tax assets

In the Balance Sheet, we add “current assets” and “non-current assets” to get the “total assets.”

Tangible assets

These are the assets that have a physical existence. As examples, we can talk about –

• Land
• Buildings
• Plant & Machinery
• Inventories
• Equipment
• Cash etc.

Intangible assets

These are the assets that have value but don't have a physical existence. For example, we can talk about the following –

• Goodwill
• Patent
• Copyright
• Trademark etc.

Fictitious assets

To be precise, fictitious assets are not assets at all. If you want to understand “fictitious assets,” just follow the meaning of the word “fictitious.” “Fictitious” means “fake” or “not real.”

That means fictitious assets are fake assets. These are not assets but losses or expenses. But due to some unavoidable circumstances, these losses or expenses couldn’t be written off during the year. That’s why they’re called fictitious assets.

The examples of fictitious assets are as follows –

• Preliminary expenses
• Loss on the issue of debentures
• Promotional expenses
• Discount allowed on the issue of shares

Valuation of assets

Can we value the assets? For example, how would a business know what would be the worth of an investment after a few years down the line! Or the organization may want to calculate the value of intangible assets like patents or trademarks.

Well, there are methods for valuing assets. But why would an organization value without any reason? It turns out that valuation of assets would be required for investment analysis, capital budgeting, or mergers and acquisitions.

There are multiple methods through which we can value the assets. There are typically four ways an organization can value its assets –

• Absolute value method: Under the absolute value method, the present value of assets should be ascertained. There are two models organizations always use – the DCF Valuation method (for multi-periods) and the Gordon model (for a single period).
• Relative value method: Under the comparative value method, the other similar assets are compared, and then the value of the assets is determined.
• Option pricing model: This model is used for specific types of assets like warrants, employee stock options, etc.
• Fair value accounting method: As per US GAAP (FAS 157), the assets should only be purchased or sold off at their fair value.

Types of liabilities

Let’s see two main types of liabilities on the balance sheet. Let’s talk about them.

Current liabilities

These liabilities are often called short-term liabilities. These liabilities can be paid off within a year. Let’s see the items we can consider under short-term liabilities –

• Financial Debt (Short term)
• Trade & Other Payables
• Provisions
• Accruals & Deferred Revenue Income
• Current Income Tax Liabilities
• Derivative Liabilities
• Accounts Payable
• Sales Taxes Payable
• Interests Payable
• Short Term Loan
• Current maturities of long-term debt
• Customer deposits in advance
• Liabilities directly associated with assets held for sale

Let’s have a look at the format of current liabilities –

Long-term liabilities

Long-term liabilities are also called non-current liabilities. These liabilities can be paid off over a long haul.

Let’s have a look at what items we can consider under long-term liabilities –

• Financial Debt (Long term)
• Provisions
• Employee Benefits Liabilities
• Deferred Tax Liabilities
• Other Payable

Here’s an example –

If we add the current liabilities and long-term liabilities, we would be able to get "total liabilities" on the balance sheet.

• Assets will pay off the business for a short/long period. On the other hand, Liabilities make the business obligated for a short/long period. If obligations are deliberately taken for acquiring assets, then the liabilities create leverage for the business.
• Assets are debited when increased and credited when decreased. On the other hand, Liabilities are credited when increased and debited when decreased.

• All fixed assets are depreciated, meaning they all have wear & tear, and over the years, these fixed assets lose their value after their lifetime expires. The only land is a non-current asset that doesn’t depreciate. On the other hand, Liabilities can’t be depreciated, but they are paid off within a short/long period.
• Assets help generate cash flow for businesses. On the other hand, liabilities are reasons for cash outflow since they must be paid off (however, there is a big difference between liabilities and expenses).
• Assets are acquired with the motive of expanding the business. Liabilities are taken to acquire more assets so that the business becomes free of most of the liabilities in the future.

This article has been a guide to Assets vs Liabilities. Here we explain it through the difference in meaning, types, examples, and other critical differences. You may also have a look at our other useful articles –

• Asset Swap Example
• Types of Contingent Liabilities
• Tangible Assets
• Key Differences - Current vs. Non-Current Assets