What are assets and liabilities?
A balance sheet is a statement that presents a financial position of an enterprise, it is necessary that it shows the assets and liabilities based on their characteristic features. If assets are the property and possessions of the business, liabilities are the legal obligations of the business, i.e., the claim by outsiders on the assets of a business. (No doubt, the Owner’s equity is also a liability that is owed by the business to the proprietors or partners.)
Classification of Assets
Assets may be broadly classified into three categories as shown in the below figure.
1. Fixed Assets
Fixed Assets can be divided into:
These are assets acquired for beneficial use and held permanently in the business. The business is able to earn profits by using these assets. Fixed assets that can be seen, touched, and have volume are called tangible assets or definite assets. For example, land, antiques, plant, buildings, equipment and tools, fixtures, vehicles. Assets that cannot be seen, touched, and have no volume but have value are called intangible assets. For example, goodwill, patents, trademarks, copyrights, leasehold.
Assets that get exhausted or reduce in value when used are called wasting assets. For example, natural resources, oil, timber, coal, mineral deposits, quarries. Assets that are either the past accumulated losses or expenses which are incurred once in the life of a business enterprise and are capitalized for the time being are called fictitious assets. These items are not actually assets but treated as assets. Because of their intangible nature, they have sometimes categorized as intangible assets also. For example, organizational expenses, discount on issue of shares, advertising expenses capitalized, research and development expenses.
2. Floating Assets
Investments on short-term marketable securities that can be converted into cash quickly can be treated as current assets, whereas investments on long-term marketable securities can be treated as semi-fixed assets. Therefore, investments do not fall under either current assets or diced assets category. Their treatment differs depending on nature and, hence, they are shown midway between fixed assets and current assets independently and considered as floating assets.
3. Current assets
Current assets are expected to be sold or otherwise used up in the near future. These assets are readily available for discharging liabilities of an enterprise. Those items of assets which can be converted into cash quickly without much loss of time and money are called liquid assets and fall under the category of current assets. For example, cash, bank balance, accounts receivables (sundry debtors + bills receivables), stock that can be realized quickly.
Classification of liabilities
Liabilities may be classified into four categories as shown in the below figure.
Liabilities can be divided into:
- Fixed liabilities
- Long-term liabilities
- Current liabilities
- Contingent liabilities
1. Fixed Liabilities
They are liabilities that are due to the owner’s/partner’s/shareholders payable only on dissolution/liquidation of the enterprise.
2. Long-term Liabilities
These are in the nature of long-term loans (say five years, ten years) or debentures that are payable on or after the lapse of the term consented to in the borrowing agreement/document.
3. Current Liabilities
These are short-term obligations payable within the next accounting period/year or payable within a very short period (say one month, three months). Accounts payable (sundry creditors + bills payable), short-term bank overdraft, short-term temporary loans are examples for current liabilities.
4. Contingent liabilities
These arise depending on the happenings of certain events. Such liabilities may or may not arise. However, there is a need to be cautious about them. For example, a case is pending in the court of law on a disputed payment or compensation claimed. If the case if decided against the enterprise, then liability arises. Otherwise, there is no obligation to pay.
Bills discounted, guarantee given against loan of another enterprise or person also may cause liability if the other person does not honor the commitment. If the person honors the commitment, then no liability arises. That means, ‘liability is probable’. ‘Probable liabilities are treated as contingent liabilities’ and a note is given for such liabilities below the balance sheet. This note helps the information users to make a proper decision.