In Accounting what are the criteria for calling something an "asset"?

Hi,

In Accounting what are the criteria for calling something an “asset”? The Chart of accounts lists types of assets but my interest is finding a broad enough definition to help me understand when to call something and asset and when not.
I look forward to your feedback
davidmich

An asset is something valuable. Anything of value.

For an asset to be listed in a company’s books, the company must own the asset.

If you see any item or piece of property (either tangible or abstract like IP), and you think to yourself, “Hmmm, somebody might potentially give me money for this”, then it has value. It is an asset.

Pretty simple.

Thanks Hellestal. That’s pretty clear.
davidmich

Note that assets can be rather intangible or abstract, or some “virtual” quantity (just a number in a ledger book) that you expect might have some real value in the future.

An account receivable is an asset. That means, if somebody owes you money, and you reasonably expect that it will actually be paid to you, then you can count that money as an asset, even though you don’t have possession of the actual money. You could even sell this asset to somebody else.

So it can be rather subjective, then, can’t it? And that would mean that when presented with a valuation of a concern based upon assets that the value very much can depend on who is doing the evaluation, right?

This depends on what you mean by “it”.

Whether something is an asset is a fairly objective question. I might not know exactly how much my somewhat old sofa would fetch, but I’m fairly confident that if the price went down far enough, I could unload it. It might get down to a matter of pennies if it’s bad-looking enough, but those are still pennies. And the related idea: I know that replacing the sofa would cost me money that I would willingly spend, so if I continue to use what I have with the full knowledge that I’d find some replacement if I didn’t have it, there is self-evidently some value there that it continues to provide.

We might point at small-value cases, but even then, we have items that are clear assets. Looking at a half-used container of deodorant, we might wonder if it still has positive value for anyone else but me. Would anyone want to buy it? Well, it’s an outside shot but possibly yes, maybe, at one cent or so. But replacement is still an issue. I know that if it disappeared in a puff of smoke tomorrow, I would immediately pay to replace it. That is an objectively observable fact. Deodorant clearly is an asset for me, and don’t you listen if my friends say otherwise.

But with the accounting, you’d just expense out something that small. It’s clearly valuable, clearly an asset, but it’s just as clearly a waste of time to list all two dollar items of negligible resale value.

Yes.

The actual value of an asset is a big mysterious question mark. This is the part that is rather subjective. Real-world accounting follows strict rules for consistency, but the truth is that the real-world value of objects is almost never what it says on the balance sheet.

Example: If I’m starting a new manufacturing business, I might buy the new machinery for one million dollars. Since that’s how much I paid, and it is also the rough replacement cost, then that’s the value I’m going to put down in the books according to the rules. But is the machinery really worth a million bucks if it’s used in the purpose my business is allocating it to? No. I’m almost 100% certain that the machinery is not worth the million bucks listed in the ledger. What is it actually worth? We don’t know. If the business ends up being highly successful, then the machinery was clearly worth more to me than what I initially paid for it. I’m the one who saw that a million dollar purchase of this sort of machinery could win me even more money because I chose the right application for it, so I’m going to rake in a profit for that. And the very fact that the business is profitable lets us know that the machinery – in this context, within this business, under this management – is more valuable than what I spent to acquire it.

Similarly, if the business fails, then that machinery is clearly worth less than the million I spent for it. It’s still an asset, but it was allocated to the wrong purpose, meaning it’s actual value is just as scrap metal. Resale of that asset will go for a small percentage of what I originally paid. So yes, absolutely, valuation of assets is extremely subjective and tough. Even for a historically successful company, we can’t know with any certainty how successful they will continue to be out into the future.

This is why we rely on the trial-and-error of the business world to make these sorts of choices, rather than having centralized decision-making. There are way too many decisions to make, too much relevant information that is dispersed among too many people, to have any hope of bringing order and efficiency to this system using any kind of centralized authority.

how would Facebook do the bookeeping for the acquisition of Whatsapp?

Very technically, you count the promise as an asset that is worth the money. You don’t count the money, because you don’t have it.

MRO items (Maintenance, Repair, Operations), even though they carry a value and you own them are not considered an asset but rather an expense.
We carry an ongoing inventory of $4 million worth of spare parts for our manufacturing equipment all of which has been expensed.
Likewise things like chairs, desks, computers, office supplies are often expensed and not considered an asset.

Check out the concept of “goodwill”, which as far as I can see is “assets-liabilities is X, but someone wants to pay Y > X for the whole lot, so here’s a category for Y-X”.

It was previously mentioned that smaller items tend to be expensed for accounting purposes.

It’s $4 mil of spare parts in aggregate, but how much is each individual piece worth? What’s the most valuable individual piece that you are legally allowed to expense out?

All companies want to speed up their depreciation schedules for tax purposes, but that doesn’t really cut to the heart of what an “asset” is. It’s a legal wrinkle on top of the basic concept, and that’s why it’s very easy to imagine an alternative tax regime where your $4 mil would stay on the books.

Conversation at a factory where we were going to install the new and shiny management software:

Maintenance manager and factory manager: “Some of our spare parts are so costly we want to be able to depreciate them, so they have to be treated as assets.”
Finance consultant: “They’d have to be worth a real big huge lot, for that… how long can pass between buying one and using it, anyway?”
Maintenance: “Years, there are some parts which would take weeks to arrive if we didn’t have them in inventory when needed and that would mean having the factory shut down during that time. This valve [puts a large valve on the table] costs 120K and it’s not the most expensive part. If its sister that’s installed breaks down and we don’t have a replacement, the factory shuts down.”
Consultants team picks jaws up from where they’ve fallen off and writes down “some spares will be treated as assets.”

Refurbishing of both machinery and spare parts can be treated as re-upping the value of an asset, and depending on the local tax structure, the question can be “what’s the smallest thing you’re legally allowed to depreciate over time?”.

When a business buys a thing, it has a decision to make: Is this thing for immediate consumption, or will I be owning it and using it up over time?

If it’s to be consumed immediately, it’s treated as an expense. If not, it’s treated as an asset. In general, assets are “depreciated”, which is simply recognizing the idea of using something up slowly over a long period of time.

My comment above essentially turns the question of “expense vs. asset” into “immediate vs. over time.” Which then raises the question: What’s “immediate” in the context of business? The answer generally is one bookkeeping period. Typically a calendar quarter or a year.

And last of all, the de minimis rule of thumb indicates that items whose cost is trivial on the scale of the business be expensed immediately rather than treated as assets and depreciated, regardless of the reality of how long it takes to use it/them up.

http://www.netplaces.com/accounting/standard-operating-expenses/all-about-depreciation.htm

If any of you were auditors and auditing the books of a company, what shenanigans/red flags (and there are many I’m sure) in terms of claiming sth as assets/expenses would you be alert to?

davidmich

Allowable depreciation is one. Another is impairing a tangible asset like inventories or property that you foreclosed. IFRS/GAAP require that you put in the realizable value when valuating and impairing. That means you get the actual likely value of the sale less various costs to sell. Carefully consider the assumptions for selling (how much, how long to sell? up front? on installment?)

If you’re looking at a real estate developer, check whether or not he is allowed to capitalize his interest expenses on his bank loans. If capitalized, the expense become part of his inventory and will be expensed out only if the unit is sold.

Going back to your first question, the accountant will have to decide whether something is an investment (asset) or an expense (period.) Also whether something is a liability or a revenue.

For something to be an asset the company has to own it. It is common to judge the performance of a company in relation to its assets, so it is often a good policy to keep that figure as low as possible. The above company, with its million Dollar machine would have leased it and kept it off the register altogether.

Assets = Liabilities + Equity

I have $50 that I give to my business. This is “Equity”, my personal financial share of the business.
My business borrows $75. This is a “Liability”, money the business owes to others.
I purchase a $125 piece of equipment. This is an “Asset”, the value of what the business owns.

Thus $125 = $75 + $50. If I sold my business right now for $125, I’d pay off the loan and wind up with my original $50.

Revenue - Expense = Income

Alternately, I can do a job with the equipment and get paid $20, this is “Revenue”. I had to pay $3 to buy a blank invoice form to bill the customer, this is “Expense”. My “Net Income” then is $17.

If I then pay the $17 to the loan, the first equation becomes:

$125 = $58 + $67
The value of the asset is the same, the liability has gone down, so now my equity must go up.

This is a very simple example. To the OP, typically if an item is known to generally last longer than one year, it is accounted as an asset. If the item typically last less than one year, it is accounted as an expense. The value of the asset is usually the purchase price. As time goes on, the asset will be losing value. How this is dealt with in accounting is fairly well described in IRS pub 946, “How to Depreciate Property”.

Thank you all very much. Very helpful.
davidmich