Asset account is a subcategory within a company’s general ledger depicting the value of assets owned by an organisation. The assets owned by an organisation represent economic value and are expected to provide benefits in the future.
For businesses, these assets also find their way into the balance sheet, and for them, they also generate cash flow and reduce expenses while improving sales. Furthermore, these assets are classified as current, fixed, financial, and intangible.
Moreover, it’s an asset account balance, in which debit balances increase with a debit entry and decrease with a credit entry. Confusing right? Well, read on ahead as we decipher everything you need to know what is an asset account with examples.
Definition of an Asset Account
According to Investopedia, “An asset is a resource with economic value, which an individual, company or a country owns or controls with an expectation that it will provide a future benefit.”
At the same time, Collins Dictionary defines an asset account as “an account that records the assets owned by a company.”
Let’s decipher this for a better understanding.
Businesses think of assets as items of value that are easily converted into cash when required. Moreover, assets are supposed to generate income and appreciate value with time. At least, this is what is expected of every asset, be it bonds, stocks, real estate, bullion, artwork, etc.
At the same time, in business parlance, an asset is something that has the potential to generate cash flow, reduce expenses, or even help increase sales. This is regardless of the fact that an investment is tangible equipment like a fleet of trucks or an intangible asset like a patent or trademark.
Types of Asset Accounts
Assets are classified based on their convertibility, physical assistance, and their usage. Knowing all the types and their workings is critical for the company’s survival, specifically understanding their solvency and associated risks.
Source: Corporate Finance Institute
1. Current Assets
Current assets represent resources with an expected potential to be converted into cash or utilised within one year or an operating cycle, whichever is longer. Companies need these assets for day-to-day business operations and to supply liquidity to cover short-term obligations.
Examples of current assets are:
- Cash and Cash Equivalents: A liquid asset, including fiat cash and short-term investments the company has made into treasury bills or money market funds. For instance, when a business has ₹50,000 in its bank account and ₹$10,000 in a money market account.
- Accounts Receivable: These are the funds a company expects to receive, which means its owed by customers for goods or services that the company has delivered but has not yet received payment for them. For example, when a retail store has outstanding payments to be received of ₹5,000 by a customer who purchased products on credit.
- Inventory: Simply put, these assets are goods available for sale or are stored in the warehouse in the normal course of business. For example, when a furniture store holds ₹200,000 worth of tables, chairs, and sofas in its inventory.
- Prepaid Expenses: These represent payments made for expenses that will benefit future periods, such as rent or insurance. For instance, when a company pays ₹12,000 for a one-year insurance policy in advance. Each month, part of this prepaid expense is recognised as an expense.
2. Fixed Assets
You can consider fixed assets as a subcategory of non-current assets, which are tangible and they are utilised for the long-term operations of a business. However, these assets are also subject to depreciation over time (except for land, which, in most cases, appreciates over time. For businesses, fixed assets are the key to the production and operational capability of a company.
Common examples of fixed assets are buildings, which can be warehouses, factories, or even office space that the company owns and uses for business operations. Then, there is equipment, machinery or tools used in manufacturing or office operations. More so, the vehicles a company owns are also a part of its assets.
3. Intangible Assets
Source: Pinterest
Intangible assets are non-physical assets without any physical presence. These assets are economic resources which do hold some value today and in the future, depending on their nature and usage.
Examples of asset accounts in this category include patents, trademarks, copyrights, and goodwill. So things like a company’s logo, a patent that says only Company A can process a certain type of medicine, etc., are intangible assets.
These assets provide long-term value to a company. The key function of these assets is to generate revenue or provide competitive advantages to the company, which it can use to increase sales and reputation.
While all other intangible assets are self-explanatory, let’s discuss goodwill. This is a company’s brand value, its stature in customer relationships, or other unquantifiable assets when acquiring another business. Imagine an organisation buying for ₹1 crore more than its net asset value. This extra amount is recorded in the books as goodwill.
4. Financial Assets
One of the most important and underrated assets, financial assets means the ownership or a right to receive potential financial value today or in the future. The reason these assets are seen with some scepticism is because of the market forces at play that can change how these assets are affected by them.
For instance, stocks and bonds, which are financial assets, may take a downturn in terms of value due to a company shutting down, an economic collapse or a disaster in another part of the world.
Still, when invested smartly, stocks, bonds, or cash equivalents can turn out to be great investments. Their primary function is investment and to earn income through dividends, interest, or capital gains.
In addition to these four asset types, the ledger books have another category, operating assets. These are assets that are used in daily operations and contribute to a business’s revenue generation. Companies need these assets to run their daily operations smoothly.
Importance of Asset Classification and Analysis for a Business
Business asset classification is a crucial part of every business. This categorisation is a strong indicator of a company’s financial health. A company with discrepancies in its accounts will definitely suffer from losses and even run into trouble with the authorities at the time of reporting. Here’s why you need to be on your toes when it comes to asset classification.
1. Ensure you are Accurately Reporting your Financials
Timely and accurate classification is important to build accurate financial statements including balance sheets, which are used by stakeholders and investors to evaluate your company’s position and financial health.
So, accurately classifying assets into current, non-current, fixed, and intangible assets helps them have a clear and structured view of a company’s financial health and future outcomes, and numbers speak volumes about a company’s future.
For instance, when the balance sheet shows current assets like cash and accounts receivable, depicts the company has liquidity, it ensures the business can sponsor the daily operations and the non-current assets like buildings show long-term stability.
2. Better and Business-Centric Decision Making
With a proper understanding of different asset categories and noting down the accurate information is pivotal for the management to make informed strategic decisions.
For instance, managers within a company can optimise resource allocation, which means they can easily decide between investing in fixed assets or liquidating current assets to fund short-term projects.
Such information can be used to check if a company that has excessive inventory but low cash can decide to sell off stock, even at lower prices than usual, to improve liquidity.
3. Managing a Company’s Liquidity Effectively
Accurate asset account classification and creation helps businesses manage their liquidity, which is their ability to meet short-term obligations. As the accountants classify assets as current or non-current, it demonstrates how a business can convert their assets into cash to meet short-term liabilities like bills, payroll, and taxes.
Understand that a company with high accounts receivable but is low on cash at present may not be able to pay bills, especially if the payments are delayed any further. Hence, understanding liquidity from current assets allows the business to plan better.
4. Allocate Resources to Ensure Operational Smoothness
Effective asset categorisation and classification allow for the optimal allocation of resources to every department and various parts of the business.
This is even more important as knowing which assets are operational, including inventory or machinery, versus those held for investment, like marketable securities, financial experts businesses can diversify capital allocation as and when required.
5. Ensure Compliance with Taxation Policy
Given the complex taxation structure businesses have to follow, which also changes according to the country of operation, ascertaining your records are straight is essential. More importantly, different types of assets have varying tax treatments and regulations.
So, where fixed assets, including machinery and equipment, require depreciation calculations over time, intangible assets may require amortisation. At the same time, current assets and assets required for daily operation may not have to undergo such accounting adjustments.
A simple example is when businesses depreciate the machinery to reduce taxable income, but they won’t depreciate liquid cash or inventory.
6. Ensure Transparency with Investor and Stakeholder Communication
Accurate asset classification is important for businesses to demonstrate their financial strength and potential to grow with investors and other stakeholders.
Even investors consider the asset balance sheets, evaluating current, fixed, and intangible assets, among others, to know whether the company is stable and has the ability to generate future profits while effectively managing risks.
7. Build Long-Term Plans for the Organisation
Asset accounting plays an important role in developing long-term financial strategies and plans. One of the examples where this planning is seen is when asset classification differentiates between non-current and intangible assets, such as real estate or patents, that are central to planning future expansions, product development, or mergers.
8. Manage Costs and Ascertain Company Profitability
Another reason for proper classification of your assets account is that it helps in managing costs and improving profitability by identifying where value is created or diminished.
Cost management through asset accounting is essential because by understanding the gap between operating and non-operating assets, it’s easier for a business to focus on improving the efficiency of operational assets while staying focused on using non-operating assets.
How Mocha Accounting can Help with Asset Account Management?
Mocha Accounting is a valuable tool for asset accounting, especially when you see it from the management perspective. With Mocha Accounting, businesses can streamline their entire asset management process by offering comprehensive asset tracking through in-built features like invoicing, inventory management, sales, and purchase order tracking.
Moreover, our tool is built with automation capabilities to ensure you don’t make data entry mistakes and have accurate reporting. With Mocha, you can also centralise asset management to drive operational efficiency and make better financial decisions.
To Sum It Up
Asset accounting is a critical part of every organisation’s financial management. Effective financial management has benefits like better visibility and transparency, leading to precision financial decision making and reporting.
Incorrect asset classification can lead to poor decision making and tends to force businesses into tight spaces where operational risks and financial distress are common.
So streamline your asset accounts with tools like Mocha Accounting to build a secure and financially strong organisation.
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