What are Assets?

An asset—in its most basic sense—is "anything and everything that a business owns or provides as a service that has the potential to be turned into cash." Examples could include inventory, equipment, tools, materials, cash, investments... all of these add value because they can be used in the creation of products, can be sold directly, or can be converted to cash. 

Assets can be broken into two categories: current and fixed. Understanding how those categories affect a business and how to track them on financial statements are important parts of being a bookkeeper.

"Assets" isn't an all-encompassing term

Assets can be broken down into two types: current assets and fixed assets.

Let's look at these more closely.

Current assets

Current—or short-term—assets include cash and items that will be converted into cash quickly, typically within a year (12 months).

Current assets are vital for a business's day-to-day operations. They help a business meet its short-term financial obligations. For example, if a business needs to pay its employees or its suppliers, it can use its current assets to do so. Types of Current Assets

Cash and cash equivalents

Cash and cash equivalents include accessible money, funds in bank accounts, and short-term, high-quality investments that can be easily accessed within 90 days, such as certificates of deposit. 

Accounts receivable

Accounts receivable is the amount of money that clients owe to a business in exchange for the goods and services that the business has provided on credit to the client. 

Inventory

Inventory is the raw material a business uses in the production of finished goods as well as the finished goods and purchased merchandise held by a business for sale.

Prepaid expenses

Prepaid expenses are payments made in advance, like paying six months of insurance premiums. They are considered assets since the cost has already been incurred. 

Investments

Money market account balances, stocks, and bonds are all types of investments. Some investments may be categorized as noncurrent, but most are current assets. Investments in this category are also defined as marketable securities.

Notes receivable

Notes receivable refer to amounts that are owed to the business that will be paid within 12 months.

Fixed assets

Fixed—or long-term—assets are acquired to benefit the business long-term. They extend beyond a year.

Fixed assets, also known as long-term assets, are assets that a business acquires for productive use in its operations and are not intended for sale. Unlike current assets, which are expected to be converted into cash within a year, fixed assets are expected to be used by the business for an extended period, typically beyond a year.

There are two main types of fixed assets:

Property, Plant, and Equipment (PP&E) PP&E assets include vehicles and equipment used to produce revenue. These assets decrease in value over time. For that reason, depreciation expense is posted to record the decline in the value of fixed financial assets. Note that real estate (land) is also posted to this asset category, but land does not depreciate in value. Intangible Assets

Intangible assets have no physical manifestation, such as copyrights, patents, and intellectual property. They are intellectual property that holds future value. This can include assets like a business's domain name, patents, and trademarks.

Goodwill is an example of an intangible asset. For instance, if you purchase a business for $10,000, but the total value of its assets is only $7,000, the additional $3,000 represents goodwill. This goodwill reflects the reputation, prestige, and name recognition of the business. 

Tracking Assets:

• Step 1. Identify the asset type

• Step 2. Check if there's an existing account

• Step 3. If needed, add the account

• Step 4. Record the asset

Purchasing Vs Leasing Assets

Property, plant, and equipment

Property, plant, and equipment (PP&E) are the long-term, tangible assets that a business owns. They are most often fixed assets, which are long-term assets acquired by a business for operational use and not for sale. PP&E includes assets like trucks, machinery, factories, and land. These assets enable a business to run and expand its operations.

A business can acquire equipment or space by purchasing the needed items or by leasing them.

Lease

A lease is an agreement to pay rent for a specific period of time for the right to use an asset.

In a lease agreement:

• The lessor is the party who owns the asset and is renting it out.

• The lessee is the party paying the rent to use the asset.

There are two types of equipment leases: in both cases, an asset is being rented, but the main difference lies in the transfer of ownership.

Operating Lease There is no intention for ownership of the asset to transfer hands at the end of the lease. Capital (Financing) Lease The business intends to take ownership of the asset from the lessor to the lessee at the end of the lease. 

NOTE: These leases are tracked differently in the business books.

• Operating leases are expensed and are therefore not considered an asset.

• Capital/financing leases are added as assets.
  

Natural Account Balance Let's review: debits and credits

To understand natural account balance, we first need a refresher on debits and credits since they are an integral part of natural account balances. Debits increase assets or expenses, or decrease liabilities, owner’s equity or revenue.

Credits decrease assets or expenses, or increase liabilities, owner's equity or revenue. 

Remember: "Debit" doesn't mean "decrease" and "credit" doesn't mean "increase". Whether a debit or credit increases or decreases the balance of an account depends on what type of an account it is.

Normal (or natural) account balance

A normal balance is the expectation that a particular type of account will have either a debit or a credit balance based on its classification within the chart of accounts. DEA/LER

The acronym DEA/LER (debit Dividends, Expense, and Asset accounts, and credit Liability, Equity, and Revenue accounts) is a good way to think about normal (or natural) balances. Some accounts have a natural debit balance and some have a natural credit balance.

In bookkeeping, every account has a normal, or natural, balance. The accounting equation has two sides. Each sits on one side or the other of the equal sign; on one side or the other of the equation.

An account’s natural balance indicates the typical direction in which the account increases when you add to it. Accounts that reside on the left side of the equal sign have a natural balance that is on the left, or a debit balance. On the left side we find accounts dealing with assets and expenses. Assets and expenses have a natural debit balance. Accounts that reside on the right side of the equal sign have a natural balance that is on the right, or a credit balance. On the right side, we find liability, equity and revenue accounts. Liability, equity and revenue accounts have a natural credit balance.

Using the accounting equation to remember which side of the account is the natural balance will help you keep your accounts in balance.

The accounting equation

Because we're focusing on assets, let's focus on the left side of the accounting equation.  

It's all about the 'T'

Think of it this way: every account in the chart of accounts falls on either the left or the right side of the 'T'. To the left are assets and expense accounts and to the right are liability, equity, and revenue accounts. 

• All the accounts on the left side of the T, have a natural debit account balance.

• All the account on the right side of the T, have a natural credit account balance. 

The side of the account that is positive or increasing is also referred to as the natural or normal account balance. For assets and expenses:

• To increase an asset, we would debit it.

• To decrease that asset, we would credit it.

NOTE: Liabilities, revenues, and equity accounts have natural credit balances. If a debit is applied to any of these accounts, the account balance decreases. 

Now, a sales account, is a revenue account, so it naturally has a credit balance. However, if a business has refunded someone who returns a product, the bookkeeper would debit the sales account for that refunded amount. This refund isn’t typical. Normally, this sales account is, for the most part, credit.

The real benefit of knowing the normal or natural balance of an account is that when you see a balance other than what the normal balance should be— you know that a mistake has probably been made. So, if for some reason the cash account was decreasing and being credited a lot—we’d know there was something off, that we should look into it further.

By understanding the natural balance of each account, we can ensure that our clients accounting records are accurate and reliable and that the business is set up for long-term success.