What are Assets? (Let's Break Them Down)

In this video you'll discover what assets mean in accounting. I'm going to break down the definition for you and take you through some common types of asset that are worth knowing about. Hey guys welcome to Accounting Stuff. I'm James and in this video we're going to explore what assets mean in accounting. Before we dive into the good stuff I just want to make you aware that this video is part of a series that I've created on accounting basics. If you missed any of the others I'll pop a link to them up here and down in the description. That will start you off with video number one. I put out new content every week on this channel so subscribe and hit the bell to be notified when the next video is out. Right assets. What are assets? Assets are one of the three pillars of the accounting equation alongside liabilities and equity. They're hugely important because they're what businesses use to operate and generate a profit. In this video I'll break down the accounting definition of assets for you and take you through some of the common types that exist in most businesses. We accountants we like to split assets apart into different categories like current, non-current, tangible or intangible. Don't forget to watch this video through until the end because you'll discover what all of these terms mean. Let's go. I think most of us have kind of a preconceived idea of what an asset is. We think of an asset as something that we own that's useful or has value something along those lines and that's not far from the truth. Although the definition of assets in accounting is a bit more specific. Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Say what? I know. What on earth does that mean? Let's break the definition down and try to make some sense of it. The first word that stands out to me is probable. Assets are probable future economic benefits. The word probable carries with it a degree of uncertainty and I want to emphasize this because I think that often we take numbers for granted without questioning them. The reality is that the future is uncertain and a lot of the time we accountants have to make estimates. Let me give you an example. If you're running a business and you've got 10 clients who all owe you money. Can you say hand on heart that you'll receive back every penny? It's not uncommon for customers to go bankrupt or to dispute invoices after the work is done. So what accountants do in these situations is make an allowance for doubtful debts. We estimate what might not be recovered and expense it to provide for situations where there's uncertainty and that brings me on to the next part of the definition. Assets are probable future economic benefits. What are future economic benefits? These are the things that bring value to you or your business either directly or indirectly. Valuing assets based on future economic benefit means that we can't simply hold them in the books at the value that they originally cost us. Imagine you buy a laptop today and you plan on keeping it and using it entirely for work. Will that same laptop carry the same future economic benefit in five years time? Probably not. It might well have cacked it by then and not be worth anything anymore. It can be hard to measure the lifespan of a laptop so instead we assume that all laptops have a useful economic life of say five years. Useful economic life is a term that you'll hear often when talking about assets. It's how long an asset will remain useful to you and it's different to an asset's actual life because useful economic life is an estimate. So if that laptop cost you $1,000 today and we assumed a useful economic life of five years then we would depreciate or reduce its value by $200 a year for the next five years until it's worth nothing at all. Is this an exact science? No. Clearly not. But estimates like this are used every day to simplify scenarios and help accountants value assets. Lastly I want to bring your attention to another part of the definition. Assets are probable future economic benefits obtained or controlled by a particular entity as the result of past transactions or events. Obtained or controlled. This highlights another important concept that we use in accounting called substance over form. This means that when preparing financial statements we prioritize the economic substance of transactions over their legal form. An example of this is when a business rents a building for a long period of time say 60 years and that building's remaining useful economic life is 65 years. Although the business is considered a lessee and technically doesn't own the building the economic reality of the situation is that basically they do. Make sense? Because they have the right to use it for the majority of its remaining useful economic life. Following this principle of substance over form we can account for this building as an asset even though legally it isn't. That has big implications for the accounting and tax treatment of the building. Now I'm oversimplifying the situation. There are a few other factors to consider when making this call but that's the gist of it. Okay so now we know what an asset is let's run through some examples of common assets that you should know about. But first and bear with me here a balance sheet is a snapshot of a business's assets liabilities and equity at a single point in time. In the asset section of a balance sheet we list out all of the different types of assets that a business owns or controls. These assets are often arranged in order of liquidity but what is liquidity? You can think of it as how quickly you can turn an asset into cash and following that vein of thought assets in the balance sheet can be divided into two distinct categories. Current assets and non-current assets. Current assets are the ones that we can convert into cash in a short period of time. Typically within a year. The three types of current assets that show up most often are cash, accounts receivable and inventory. Inventory is your physical stock or the goods that you intend to sell to make a profit. When your business sells inventory your customers owe you money which we call accounts receivable and when your customers actually pay you your accounts receivable turn into cash the most liquid asset of them all. Other current assets include prepayments and short-term investments. You can think of prepayments as situations when you're paying for something in advance. Rent is a good example because most of us pay rent at the start of the month. At the moment that rental payment is made we need to recognise a prepayment as an asset in a balance sheet. It's an asset even though we aren't going to convert it into cash because we're going to get some of that sweet, sweet future economic benefit out of it. Remember the definition? Not all assets convert into cash. Short-term investments can be made when your business has cash to spare. You might choose to put some of that money to work by investing it in stocks and shares. This investment is considered to be a short-term investment or current asset if you're in it for the short game and you plan to sell those stocks or shares within a year's time. However, if you want to hold on to them for longer than a year they become non-current assets instead. Non-current assets are long-term assets that are used in operations to generate profits and that can't easily be converted into cash. There are three main categories of non-current asset. The first which we touched on a moment ago are long-term investments. These are the investments that we plan to hold on to for longer than a year. The other two categories of non-current assets are tangible or intangible assets. Tangible or fixed assets are the ones that have an actual physical presence. You can actually touch them. The most common types are land and buildings or PPE which stands for property, plant and equipment. These include things like furniture, machinery and cars. But not all assets have a physical presence. We call those that don't intangible assets. Intangible assets include things like intellectual property, patents, royalty rights, trademarks and copyright. If you're a photographer then you might own the royalty rights to some of your own photos. If a company wants to use one of your images for their website or blog they should pay you a royalty fee to recognize your work. So this intellectual property that you own is bringing you probable future economic benefit. It should be an asset right? The answer is sometimes. The thing with intangible assets is that they can be very difficult to value. How can you calculate the future economic value of your own licensed photos? You can't really. So most of the time businesses don't capitalize intangible assets that they've generated internally. What does capitalize mean? When we capitalize something we record it as an asset in the balance sheet as opposed to expensing it in the income statement. We only capitalize intangible assets that we've purchased from someone else and these are held at the cost value that we paid for those assets or a lower amount because we amortize intangible assets to decrease their value over time. Much like we depreciate fixed assets. An intangible asset that doesn't fit into the category of intellectual property is goodwill. Goodwill is the amount that one company is prepared to pay for another over and above the fair value of its net assets. When Facebook bought Instagram back in 2012 for something stupid like a billion dollars were Instagram's net assets at the time worth that much? Not by a long shot. The majority of that purchase was for goodwill. That's the premium that Facebook were happy to pay for Instagram's brand and potential future earnings over and above the fair value of their net assets. Thanks for watching. If you found this video useful give it a like, share it, comment, subscribe if you haven't already. As always if you've got any questions let me know down below in the comments and maybe, maybe if you're feeling generous you could send some of that goodwill my direction by following me on Instagram at Accounting Stuff. I check it every day so feel free to send me DMs with any questions you might have or maybe you just want to chat. It's all good. Fire away. As always there are new videos every week here on Accounting Stuff. See you next time. It's not cacked it yet although I did drop it whilst trying to put it in the bin. Sorry laptop didn't mean to hurt you.