In financial accounting, you’ll come across the terms “assets” and “liabilities” quite frequently. While you may have a general understanding of these terms, you probably don’t know the complete details. So, if you’re interested in learning more about assets and liabilities — and how they differ from one another — keep reading.
The Basics of Assets vs Liabilities
In the most basic sense, a liability is any financial sacrifice that a business is contractually obligated to make, whereas an asset is a financial resource of monetary value.
An asset is essentially any tangible or intangible “thing” that can be converted into real money. The International Accounting Standards Board further explains that assets are “resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.” Common examples of assets include cash, deposit accounts, accounts receivables, inventory, machines/equipment and prepaid expenses. However, long-term investments may also fall under the category of assets, including bonds, stock, property, sinking funds and pension funds. The defining characteristic of an asset is that it holds monetary value.
On the other hand, a liability is money owned by a business. When a business borrows money, it takes on debt liability. The business acquires short-term capital, though it’s contractually obligated to pay back that debt, usually with interest to the respective lender.
Calculating liabilities is essential in determining a business’s total assets. On a typical balance sheet, for instance, the formula liabilities + owner’s equity is used to calculate the business’s total assets.
However, there are two different types of liabilities that are reported on a balance sheet: current liabilities and long-term liabilities. Current liabilities are those which are expected to be liquidated within a year. Common examples of current liabilities include wages, taxes and accounts payables. Long-term liabilities, however, are those which are expected to be liquidated after a year. Examples of long-term liabilities include notes payables, long-term bonds, product warranties, leases and penion obligations.
It’s important to note that a debit can either increase or decrease the total amount of a liability. When a business deposits cash into a bank account, the bank debits an asset and credits a liability. When a business withdraws money from a bank account, the opposite happens.
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