by Assets are resources that are owned by a business and are expected to provide future economic benefits. The accounting treatment of assets is essential for understanding the financial position of a business and for preparing financial statements, including the balance sheet.
Assets are classified into two major categories: Current Assets and Non-Current Assets (also known as Fixed Assets). Properly accounting for assets ensures that a company’s financial statements reflect a true and fair view of its resources, liabilities, and equity.
Types of Assets
- Current Assets
Current assets are assets that are expected to be converted into cash or consumed within one year or within the company’s operating cycle, whichever is longer. Examples include:
- Cash and Cash Equivalents: Currency, bank deposits, and short-term investments.
- Accounts Receivable: Amounts owed by customers for goods or services provided.
- Inventory: Goods available for sale or raw materials used in production.
- Prepaid Expenses: Payments made for expenses that will be recognized in the future, such as insurance or rent.
- Non-Current Assets
Non-current assets, also known as fixed or long-term assets, are expected to provide benefits for more than one year. These include:
- Tangible Fixed Assets: Physical assets like property, plant, and equipment (PPE).
- Intangible Assets: Non-physical assets such as patents, trademarks, goodwill, and software.
- Investments: Long-term investments, including shares, bonds, or real estate held for more than one year.
Accounting Treatment for Assets
1. Initial Recognition and Measurement
- Historical Cost:
Assets are typically recognized at their cost, which includes the purchase price and any additional costs necessary to bring the asset into use. For example, if a company purchases a machine for ₹100,000, and incurs installation costs of ₹5,000, the total cost of the machine would be ₹105,000. This is the amount that will be recorded in the books of accounts.
- Fair Value:
In some cases, assets are recognized at their fair value, especially for financial assets or during acquisitions (like goodwill in mergers). Fair value is the price at which an asset can be sold in an open market.
2. Depreciation and Amortization (for Tangible and Intangible Assets)
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Tangible Assets (Depreciation):
Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. Depreciation reduces the book value of the asset and is recorded as an expense in the profit and loss statement. Methods of depreciation include:
- Straight-Line Method: Allocates an equal amount of depreciation each year.
- Declining Balance Method: Provides higher depreciation in the earlier years of the asset’s useful life.
- Units of Production Method: Based on asset usage.
Example: If a machine costs ₹100,000 and has a useful life of 10 years, the depreciation using the straight-line method would be ₹10,000 per year.
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Intangible Assets (Amortization):
Amortization is similar to depreciation but applies to intangible assets like patents or copyrights. The amortization expense is recorded periodically over the asset’s estimated useful life.
3. Impairment of Assets
- Impairment Loss:
If an asset’s carrying value exceeds its recoverable amount (the higher of fair value less cost to sell or value in use), an impairment loss must be recognized. This is recorded as an expense on the income statement and reduces the carrying amount of the asset on the balance sheet.
- Reversal of Impairment:
If the circumstances that caused the impairment improve, the impairment loss may be reversed, but not above the original cost of the asset.
4. Revaluation of Fixed Assets
- Revaluation Model:
Some businesses may choose to revalue their fixed assets (such as land, buildings, or equipment) to reflect fair market values. The revaluation surplus is recorded under the equity section, whereas a decrease in value is reflected as an expense, unless it reverses an earlier revaluation surplus.
- Frequency of Revaluation:
Regular revaluation is essential to ensure that the carrying amount of an asset does not significantly differ from its market value.
5. Disposal of Assets
- Sale or Retirement:
When an asset is sold or disposed of, the company must remove the asset from its books, including any accumulated depreciation. If the sale price is greater than the book value of the asset, a gain is recorded; if less, a loss is recorded.
Example: If a machine with a book value of ₹20,000 is sold for ₹25,000, the company records a gain of ₹5,000.
Presentation in the Balance Sheet:
- Current Assets:
These are listed in order of liquidity (how easily they can be converted into cash). Common items include cash, receivables, and inventory.
- Non-Current Assets:
These are listed after current assets, typically in categories such as tangible assets, intangible assets, and investments.
- Total Assets:
The sum of current and non-current assets, which must equal the sum of liabilities and equity (as per the accounting equation: Assets = Liabilities + Equity).
