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Tuesday, December 1, 2020

Asset vs Liability: Key Differences and Similarities

 


Did you know that America's top 100 companies had a combined market capitalization of more than $12 trillion in the year 2019?


Managing such levels of wealth requires detailed accounts management and bookkeeping. The balance sheet is among the essential accounting tools every business, whether big or small, needs to make this happen.


A typical balance sheet comprises two primary categories. These are the assets and liabilities. To successfully manage your balance sheet, you need to conceptualize asset vs liability and know the difference.


What does your balance sheet say about the health of your business? Until you understand the difference between asset vs liability, it may be hard to interpret your business' accounts. Here, we breakdown the key similarities and differences between assets and liabilities.


What Are Assets?


The best way to understand the difference between an asset vs liability is to define each of these items. An asset is anything that a business owns. Assets often add value to your business through direct or indirect inflow.


When assessing the differences between assets and liabilities, your focus should be on value addition and value reduction. Assets often increase your business' equity. Here, the Harvard Grace Corporation demystifies the general understanding of assets further for you.


What Are Liabilities?


A liability is anything in your business or balance sheet that decreases your company's value. When you categorize an item or an entry on your balance sheet as a liability, it means that your business owes another entity or should pay another business the value of such liability.


Asset vs Liability: Similarities


When assessing assets and liabilities, there're often more differences than similarities. The main similarity between the two items is that both appear on the company's balance sheet. On the same note, both assets and liabilities fall into either current or non-current items on a balance sheet.


Both assets and liabilities have balances, which are useful when balancing the business' accounts at the end of each accounting period. Further, investors are often concerned with both assets and liabilities when valuing your business. These are the main similarities between assets and liabilities.


Differences Between Assets vs. Liabilities


When preparing your balance sheet, you'll tend to notice obvious differences between an asset vs liability.


Inherent Meaning


The main difference between assets and liabilities is the inherent meaning. An asset refers to the current and future benefits receivable to your company. In contrast, a liability is any obligation your entity owes to other businesses.


The difference in the inherent meaning forms the basis on which accountants list assets vis-à-vis liabilities. When preparing your balance sheet, the difference between the total assets and the total liabilities defines your actual profits for the period.


Depreciation


Depreciation refers to a reduction in the value of assets over time. This occurrence may be due to wear and tear. When preparing a company's balance sheet, there's often a provision for depreciation. The other difference between assets and liabilities is that assets are depreciable while liabilities are non-depreciable.


The balance sheet only has a provision for depreciation for assets. If you are assessing your business's health, depreciation stands out as an expense after preparing the balance sheet.


Categorization


The other difference between assets and liabilities on a balance sheet is the categorization. While both assets and liabilities fall broadly into current and non-current categories, assets fall further into specific sub-categories.


Assets either fall into tangible and intangible assets, current and non-current assets, or fictitious assets. The subsections are critical when balancing off your balance sheet. Liabilities, on the other hand, only fall into current and long-term liabilities.


Balance Sheet Format


When preparing your balance sheet, the format is critical for ensuring that you balance off the accounts. Assets should appear on the right side of the balance sheet, considering that they increase your accounts. It's important to identify all the assets and place them, as they should appear on the balance sheet's right side.


On the other hand, all the liabilities should appear on the balance sheet's left-hand side. This ensures that you have all the items that reduce your accounts on the balance sheet's left side. In case you confuse any of these entries, you might end up struggling to balance off the balance sheet.


Calculations


Are you trying to understand the difference between assets and liabilities? It's important to understand how to calculate the value of each item. When calculating assets, you need to subtract the owners' equity from the total liabilities.


To get the value of liabilities, you need to subtract the owners' equity from the total assets. Any person trying to find your company's net value will consider these two formulas. The owner's equity often says a lot about your debt.


The Composition of Assets vs. Liabilities


The makeup of a balance sheet and your ability to balance your accounts depends on your understanding of what makes up the assets and liabilities in a balance sheet. The most common examples of assets items that should appear on your right side include:


  • Liquid Cash
  • Investments
  • Inventory
  • Office equipment
  • Machinery
  • Real estate
  • vehicles

When considering liabilities, you need to be careful to include all the items that make the left-hand side. Examples of liabilities on a balance sheet include:


  • Bank debt
  • Mortgage debt
  • Money owed to suppliers (accounts payable)
  • Wages owed
  • Taxes owed

It's important to understand where each item fits when preparing your balance sheet. One of the best ways to differentiate between assets and liabilities is to understand where each item falls on the balance sheet.


This Is How to Differentiate Asset vs Liability


When assessing your business accounts, it's critical to differentiate between assets and liabilities. Some of the main things you look for when assessing your company's performance include liquidity and equity. The only way to calculate these items the right way is to know the difference between asset vs liability.


With these similarities and differences listed in this article, you can now assess your business' accounts with incredible ease. Now, you can interpret how your balance sheet looks like.


Was this article useful? You can read more on online business, loans, and online investment in our subsequent articles.

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