Account Types: Assets

Question 1

Broadly, what are Assets?

Answer 1

Assets are what businesses use to operate and generate profit.

Question 2

What are Assets by definition?

Answer 2

Probable future economic benefits obtained or controlled by a particular entity as the result of past transactions or events.

Question 3

What are some of the most common types of Assets that exist in business?

Answer 3

Accountants like to split Assets apart into different categories like: current, non-current, tangible and non-tangible.

Question 4

What is the preconceived idea that most of us think when we think of an Asset?

Answer 4

Most think of an Asset as something we own, that is useful and has value. Something along those lines.

This isn’t far from the truth.

Question 5

The word Probable, used in probable future economic benefit in an asset, has what meaning to it?

Answer 5

In accounting, the word Probable carries with it a degree of uncertainty. The future is uncertain, so accountants have to use Estimates.

Question 6

Probability Example:

If you run a business and have 10 clients who all owe you money, can you say with certainty that you will receive every penny back?

Answer 6

No, because it isn’t uncommon for customers to go bankrupt or to dispute invoices after work is done.

Question 7

What are Future Economic Benefits?

Answer 7

The things that bring value to you or your business either directly or indirectly.

Question 8

What does valuing Assets based on Future Economic Benefits mean?

Answer 8

This means we can’t simply hold them in the books at the value they originally cost us.

Question 9

If you buy a laptop for your business and you plan on keeping it to use entirely for work.

Will the same laptop carry the same Future Economic Benefit?

Answer 9

Probably not. It can be hard to measure the life span of a laptop, so instead we assume that ALL laptops have a Useful Economic Benefit of say, 5 years.

Question 10

What is Useful Economic Life?

Answer 10

This is a term you’ll hear often when talking about assets. It’s how long an asset will remain useful to you and it’s different than an Assets ACTUAL life because Useful Economic Life is an Estimate.

Question 11

If the laptop cost you $1000 today and we assumed a Useful Economic Life of 5 years, how would we record this in accounting?

Answer 11

We would depreciate or reduce its value by $200 per year for the next 5 years until it’s worth nothing at all.

Question 12

How can Estimates be used to help accountants value Assets?

Answer 12

The same way we estimate the laptop reduction of value through depreciation of $200 per year for 5 years until no value.

Question 13

What do the terms “Obtained” or “Controlled” highlight conceptually in accounting?

Answer 13

The concept called Substance Over Form.

Question 14

What does the concept “Substance Over Form” mean in accounting?

Answer 14

Substance Over Forms means when preparing financial statements, we prioritize the economic substance of transactions over their legal form.

Question 15

Give an example of an “Obtained or Controlled” Asset with a Substance Over Form concept?

Answer 15

When a business rents a building for a long period of time, say 60 years. That buildings remaining economic life is 65 years. Although the to the business is leasing and technically doesn’t own the building, the economic reality of the situation is basically, they do. Make sense?

This is because they have the right to use it for the majority of its remaining useful economic life.

Question 16

In the building lease example, what principle allows us to account for the building as an Asset, even though it legally isn’t?

Answer 16

The principle of Substance Over Form.

Question 17

How does the principle of Substance Over Form affect the tax treatment of the building in the lease asset example?

Answer 17

It implicates the accounting and tax treatment of the building.

Question 18

RECAP

What is a Balance Sheet?

Answer 18

A snapshot of a businesses, assets, liabilities, and equity at a single point in time.

Question 19

In the balance sheet, where do we list out all of the different types of assets that a business owns or controls?

Answer 19

In the assets section.

Question 20

Assets in the balance sheet are usually arranged in order of liquidity. What is liquidity in reference to the assets?

Answer 20

You can think of liquidity as how quickly you can turn an asset into cash.

Question 21

Following the liquidity train of thought, assets in a balance sheet can be voted into two distinct categories. What are these categories?

Answer 21

Current Assets and Non-current Assets.

Question 22

What are Current Assets?

Answer 22

Current Assets are the once’s we can convert into cash in a short period of time. Typically 1 year.

Question 23

What are the 3 types of Current Assets?

Answer 23

Cash, Accounts Receivable and Inventory.

Question 24

Describe the Current Asset: Inventory.

Answer 24

Inventory is your physical stock or goods that you intend to sell to make a profit.

Question 25

Describe the Current Asset: Accounts Receivable

Answer 25

When your business sells inventory, your customers owe you money which we call Accounts Receivable.

When your customers actually pay you, your Accounts Receivable turn into Cash.

Question 26

Describe the Current Asset: Cash

Answer 26

Cash is cash! The king!

Cash= the most liquid asset of them all.

Question 27

Outside of the 3 main Current Assets: Cash, A/R and Inventory, what are some other types of Current Assets?

Answer 27

Pre-payments and Short-term Loans.

Question 28

Why is rent a good example of a Pre-payment?

Answer 28

Most pay rent at the beginning of the month. Good example of paying for something, or receiving payment in advance.

Question 29

How would you record Rent if you owned a property with a paying tenant?

Answer 29

The moment you receive the payment for rent, you need to recognize the Pre-payment as an Asset in the balance sheet.

•This is an asset, even though we aren’t going to convert it into cash.

(Because we are going to get some of that sweet sweet Future Economic Benefits out of it).

Not all Assets convert into cash.

Question 30

Describe Short-Term Investments.

Answer 30

Short-Term Investments are investments that can be made when your business has cash to spare.

You might choose to have some of it work in stocks or shares.

You are in it for the Short-Term if you plan to sell those stocks within 1 year.

Question 31

If you hold onto an Asset for more than 1 year, what does it become?

Answer 31

A Non-Current Asset

Question 32

What are Non-Current Assets?

Answer 32

Non-Current Assets are long term Assets used in operations to generate profits and they CAN’T easily be converted into cash.

Question 33

What are the 3 main categories of Non-Current Assets?

Answer 33

1. Non-Current Assets: these are long-term investments you plan to hold for more than 1 year.

Question 34

What are Tangible Assets?

Answer 34

Tangible assets or fixed assets, are the things that have an actual physical presence.

You can actually touch it.

Question 35

What are the most common types of Tangible Assets?

Answer 35

Land and Buildings are the most common.

AKA Plant, Property and Equipment (PPE)

These include things like furniture, machinery and vehicles.

Not all Assets have a physical presence. We call those Intangible Assets.

Question 36

What are Intangible Assets?

Answer 36

Intangible Assets include things like intellectual property, patents, royalty rights, trademarks and copyright.

Question 37

PHOTOGRAPHER EXAMPLE

If you are a photographer, you might own royalty rights to your own photos.

If a company wants to use your images on their website or blog, what should they do?

Answer 37

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.

Question 38

PHOTOGRAPHER EXAMPLE CONT

The royalty rights you own for images are Intellectual Property that you own.

Should’nt this be an Asset?

Answer 38

The answer is sometimes.

Question 39

PHOTOGRAPHER EXAMPLE CONT

Intangible Assets can be very difficult to value.

How can you calculate a Future Economic Value on your own licensed photos?

Answer 39

You can’t really.

So most of the time, businesses don’t capitalize intangible assets they have generated internally.

Question 40

What does Capitalize mean in accounting?

Answer 40

When we capitalize something, we record it as an asset in the balance sheet as opposed to expensing it in the income statement.

(Think this one out!!))

Question 41

When is the only time we capitalize Intangible Assets?

Answer 41

We only capitalize intangible assets that we have purchased from someone else.

These are held at the cost value we paid for these assets. Or a lower amount because we Amortize intangible assets to decrease their value over time.

Much like we depreciate fixed assets.

Question 42

What is an intangible asset that doesn’t fit into the category of “intellectual property”?

Answer 42

Goodwill

Question 43

What is Goodwill?

Answer 43

Goodwill is the amount that one company is prepared to pay the other, over and above that their value of its net assets.

Question 44

What is an example of Goodwill?

Answer 44

In 2021, Facebook bought Instagram for something stupid like $1 Billion. (Instagrams net assets were not worth that much by a longshot.

The majority of that purchase was for Goodwill. That’s the premium Facebook was HAPPY to pay for Instagrams brand and potential future earnings over and above that their value of their net assets.

Question 45

Where does the concept of Goodwill often arise?

Answer 45

In Acquisitions.