A resource of a business entity that is owned and controlled by the business is known as asset. This resource has an economic value and inflow of economic benefits for business probable from it.
Any future obligations of a business entity that are raised in result of a certain past events due to which out flow of economic benefits is probable is known as a liability.
Assets = Liabilities + Owner’s Capital/Equity of business
Liabilities = Asset – Owner’s Capital/Equity of business
Difference between assets and liabilities
Difference between assets and liabilities
1. Primary difference:
The primary difference between an asset and a liability is that assets are economic resources that a business uses to earn profits and liabilities are economic obligations that a business has to pay sooner or later in future.
There are two main types of business assets; current asset and non-current assets. Current assets of a business are those assets that are likely to exit a business within a span of financial year or 12 months. Short-term cash funds, inventory, business receivables etc. are some examples of current assets. Non-current assets are those assets which are acquired for log-term use in a business and are likely to remain in ownership of the business for more than a financial year or 12 months. Buildings, vehicles, plant and machinery etc. are some examples of non-current assets. Just like assets, there are two main types of business liabilities; current liabilities and non-current liabilities. Those liabilities which a business expects to settle during a financial year or 12 months are known as current liabilities. Bank-overdrafts, payables etc. are some examples of current liabilities. Liabilities which a business plans to settle in more than one financial years or more than 12 months are known as non-current liabilities. Long-term loans, issued bonds and debentures, post-retirement employment funds etc. are some examples of non-current liabilities.
To recognize a resource as an asset of a business, it is very important that the business must have a proper control over its use and on any commercial benefits that it derive. This is the most important feature of an asset, because if an asset is solely owned by the business but business is unable to attract its benefits, such a resource but will not be considered an asset. For example, a business owns a building which it has given on lease to a third party, although in legal terms it will be an owned asset of the business, but as business is unable to exercise any controlling rights over it until the lease term in concluded it will not be considered an asset in accounting terms. A liability is recognized when it is raised due to a certain past event and business has a legal obligation to fulfill it. If a liability is only of a constructive nature, such a liability will not be recognized as a real liability of the business. For example, a business maintains some charitable donations to a local NGO. Now, although due to the consistency of the act business will have established a constructive liability towards that NGO, it will not possess binding status.
Businesses treat their assets and liabilities based on the rules and regulations of different international accounting standards. For example, IAS-2 Inventories, provides detailed rules about the treatment of inventory of a business, IAS-16 Property, Plant and Equipment, provides rules about the treatment of non-current assets owned for use in business, IAS-40 Investment Property, provides rules about the treatment of property held for capital appreciation, IAS-37 Provisions, Contingent Liabilities and Contingent Assets, provide rules about the disclosure of contingent assets and contingent liabilities etc.
Assets vs liabilities – tabular comparison
A tabular comparison between assets and liabilities is given below
|Any resource which is owned and controlled by the business.
|Any obligation which is legally owed by the business to a third party.
|There are two main types of assets: non-current assets and current assets.
|There are two main types of liabilities: non-current liabilities and current liabilities.
|An asset is recognized in accounting terms only if business has total control over its use.
|A liability is recognized if the business is liable to fulfill an obligation legally.
|IAS-16, IAS-2 etc. are some related international accounting standards.
|IAS-37 is a related international accounting standard.
Every business owns assets which it utilizes to earn profits and has liabilities that it has to settle. More number of assets than liabilities indicates that the business is running effectively but the optimal level of assets and liabilities in a business depends upon the individual requirements and needs of that business. However, according to normal practice of business, current-assets of a business must always be more than its current liabilities to maintain a stable level of working capital which is very important to meet the short-term cash requirements of a business. This is because, it is highly possible that a business is profitable but lack of meeting its short-term obligations leads to liquidity problems.