4.2 Assets and liabilities
As the income statement groups together like items of income and deducts like items of costs to show a profit or loss for an accounting period, the balance sheet also groups together like items to show the financial position of an entity at the end of its accounting period. It is rather like a ‘snapshot’ of the entity at that moment in time. Determining a financial position is something that individual people frequently do as well, and involves sorting out what, as a person, you own and what is of value to you, often in terms of money and things like houses, cars, jewellery, furniture, etc. These types of things are called assets and the term means much the same in an accounting context as well. Determining a financial position also involves sorting out what, as a person, you might owe to other people – by way of things like mortgages, loans, credit card bills, unpaid bills for utilities, etc. These are called liabilities . If the value of your assets exceeds your liabilities, you could (in theory, at least) sell your assets, realise cash and settle your liabilities.
Assets and liabilities have been carefully defined by the International Accounting Standards Board (IASB). Assets are resources controlled by a business as a result of past events and from which future economic benefits are expected to flow to the business. They might be things the business owns, like machinery.
Businesses try to establish a financial position in a similar way at the end of an accounting period. They may have various assets, such as land and buildings, plant and machinery and vehicles, which they use to carry out business, manufacture goods and deliver them, and which they intend to keep for a long time. These are referred to as non-current assets or fixed assets . ‘Fixed’ here does not necessarily imply that assets are immovably fixed in one place (though many kinds of these assets often are); rather, it implies ‘lasting’. Many non-current assets, such as land and buildings, plant and machinery and vehicles, etc., are also referred to as tangible assets in that they have a physical form and can be ‘touched’ (the basic meaning of the word ‘tangible’). It follows that there are also intangible assets which are things that cannot be ‘touched’, such as patents , copyrights , trademarks , etc., though their existence may be confirmed by some kind of documentation. Businesses may also have items which they have bought to use in manufacturing, such as raw materials, but have not yet used. These will be used up in the course of manufacturing, and are often referred to as inventory or stock . They form one of another category of assets known as current assets , which either stay with a business entity for only a short time, or change over time. They perform a different role in the business from non-current assets. A business will not have exactly the same type or amount of raw materials in stock at the end of every accounting period, but will keep buying in materials as and when required, as it continues to manufacture and sell goods, so from one accounting period end to another, these items will not be the same. Businesses may also have stocks of finished items, which have not yet been sold, or stocks of items which are only partly finished ( work in progress ).
Other types of current assets are cash and amounts due from customers who have not paid for goods sold to them, referred to as trade receivables (' receivables ' for short and sometimes also referred to as trade debtors ).
Businesses also have liabilities in a similar way to individuals. They buy from suppliers, and may not pay for goods immediately, so at the end of an accounting period may owe money for such goods, referred to as trade payables (' payables ' for short and also sometimes referred to as trade creditors ) or for utilities such as gas, electricity or telephone charges. Businesses also borrow money from banks or other lenders to start or continue business. Also, owners of businesses invest their own money in business, most often when business commences. Money, resources or assets put into a business by owners are referred to as owner’s interest , equity or, commonly, as capital , though this latter word can be used to mean other things as well. As money, resources and assets will eventually be repayable to a business’s owners, this may also be regarded as a type of liability. Generally, liability items are classified by reference to when they need to be paid. Those due more than a year after the end of the accounting period are referred to as non-current liabilities (or long-term liabilities ). Those due within a year or less are called current liabilities . Amounts due in respect of trade payables will be current liabilities as such amounts are often due within three months or less, whereas loans may not be repayable for several years.
Liabilities are present obligations of a business arising from past events, the settlement of which is expected to result in an outflow from the business of resources embodying economic benefits. They might be sums of money owed to lenders, for example, who have loaned money to a business, and who will need to be repaid in due course.