Lesson Objectives:- Defining what an asset is
- Characteristics that embody assets
- Identifying assets based on their transaction activity
- Real world applications of the asset criteria
When you think of an asset, there can be many different things that come to mind. Cash, physical property, land, trademarks and so on. Assets can either be tangible, meaning a physical asset, or intangible, which lacks substance but has economic value.
Assets are defined as the probable future economic benefits that are controlled by a business entity as a result of past transactions or events.
Current assets are items that the company can easily access such as cash, manufacturing supplies and accounts receivable. In contrast, long term assets are positioned to be kept for an extended period of time for items such as investments, machinery and vehicles.
In order to accurately record transactions and prepare financial statements, you must be able to decide whether something is an asset or not. Instead of looking merely at the textbook definition, the easiest way to identify assets is by looking at the three main characteristics.
The following characteristics are embodied by assets:
1. They involve a future benefit: revenue or growth.
2. The business has control over the access to the benefit. This simply means that the company legally owns the assets and the risks and rewards remain connected.
3. The transaction has occurred or is more likely to occur than not. If it is positioned with a very high chance to occur and is measurable, it can likely be recorded as an asset.
Look at the chart above for various examples of assets and see how they have the characteristics of assets.
Now that you know how to identify an asset, let's put your skills to the test with two real world examples.
Example 1: A manufacturing plant purchased a new piece of equipment that is used for packaging products. The equipment was financed through the bank, meaning the company purchased it on credit.
Now, can this machine be classified as an asset?
Let's review the asset criteria:
Does it involve a future benefit of revenue for the business?
Yes, the products created using the machine will be sold for a profit.
Does the business control the benefit?
Yes, it was purchased using debt and the plant owns the equipment.
Has the transaction occurred?
Yes, the machinery has been purchased.
We've answered yes to all three questions. In this case, it is easy to conclude that the manufacturing equipment is considered an asset.
Let's look at another example that is not very straightforward. Keep in mind if the answers to the criteria are not clear, use your best judgement to determine whether it is an asset.
Example 2: A corporation is leasing an airplane for $4,000,000 per year and they sell tickets to fly passengers to locations all over the world. The lease is signed for yearly payments with a purchase option price of $20,000,000 at the end of a 5-year term.
Is the airplane considered an asset?
Here are the criteria again:
- Does it involve a future benefit of revenue for the business?
Yes, the plane tickets will be sold for the company to receive revenue.
- Does the business control the benefit?
They have partial control, they can use the airplane but the person who owns the plane technically has full control.
- Has the transaction occurred?
Yes, the transaction has occurred.
In this example, the control over the benefit is not crystal clear in the case of the lease. Since the corporation has the option to purchase the plane at the end of the lease, we can consider the plane as an asset. Leases without a purchase option are not considered assets; the transaction has not occurred if there is no chance of formally purchasing the leased item.
Leases can be difficult to determine whether something is an asset or not. Often, you have to look at the length of the lease and potential for purchase and use best judgement to decide whether it can be classified as an asset.
Items that are consigned are not considered assets because you are not legally purchasing them, meaning the transaction has not occurred. If the item doesn't sell, you won't be responsible for the costs.