Balance sheet components: Assets

The hardest thing about the balance sheet is deciphering the vocabulary on it. Once you learn what a few things mean, the sheet is much easier to read. Before you can understand the individual accounts in each section, it is important to understand the three main sections on the balance sheet.

  • Section 1 – Assets – (these may be again classified in the balance sheet as fixed assets and current assets). But for the time being, let’s see what assets are- Assets are what the company owns. Example – land, buildings, factories, machinery, vehicles, computers, furniture, cash, bank balance in company’s account etc.. , it also includes receivable amounts from customers, tax authorities, government and other entities.
  • A company can also have fixed deposits in banks. That’s not all , it can have deposits for various purposes like rent deposit, advance given to suppliers etc , it can invest in shares, mutual funds  and bonds.. these amounts also form part of the company’s assets.
  • A company may also hold finished goods which are meant for sale. In some cases , work may be in progress. For example –,Late’s take a car factory. As on the balance sheet date, the company will have finished cars ready for sale as well as partly finished cars.  These are collectively called ‘inventories’. The value of ‘finished goods’ (Fully made cars) and ‘work-in –progress’ (partly made cars) forms part of the assets of the company.
  • Prepaid assets are another category of asset that may be seen in a balance sheet. In the course of every day operations, businesses will have to pay for goods or services before they actually receive the product. For example rent may have to be paid in advance for a year. Sometimes companies may decide to prepay taxes, salaries, utility bills,  or the interest on their debt. These would all be pooled together and put on the balance sheet under the heading ‘pre paid expenses’ or ‘pre paid assets’.By their very nature, Prepaid Expenses are a small part of the balance sheet. They are relatively unimportant in your analysis and shouldn’t be given too much attention.
  • There’s one more class of assets – intangible asset – ie, assets which appear in the balance sheet in the form of a ‘value’ but which cannot be seen , touched or felt. These include copy rights, trademarks , intellectual property, patents goodwill etc..

So that’s it for the first component in the balance sheet – Assets. Add them all up and you get the total assets owned by the company. Simple.

ASSET VALUE : MORE OF ESTIMATES AND ASSUMPTIONS

One important point to take note here is that, the value of most of the asset components discussed above as shown in the balance sheet is derived based on certain estimates and assumptions. For example – Property, plant and machinery, computers , furniture and fittings and all those equipments that the company use to operate business are accounted in the balance sheet at the purchase price in year one and in the subsequent years , a fixed rate of depreciation is charged on it and the balance is shown as the value. But in reality, nobody knows how much the company’s real estate or equipment might be worth in the open market. The fact that companies must rely on purchase price to value their assets can create some anomalies. Let’s discuss some examples here:

  • you started a company 25 years back and bought land For 25 lakhs. The land could be worth 5 or 6 crores today – but it will still be shown at 25 lakhs in the balance sheet. Since land does not wear out, depreciation is not charged on land each year.
  • In the case of machinery and other fixed assets, depreciation is charged at a fixed rate by the accountants. So , when you buy machinery worth 25 lakhs, it’s shown in the balance sheet after charging a depreciation of say, 10% or 15%. Two years down, this machinery may not have a reliazable value at all due to various reasons – for example technological obsolescence but, may still appear in the balance sheet at cost (25 lakhs) less depreciation charged (say at 15% for two years) at 18.06 lakhs.
  • A company may have intangible assets ( goodwill, intellectual property, customer base , strategic strength, brand image etc..). These are assets which exists but you cannot touch or spend. Most of these assets are ‘created’ over time and are not found on the balance sheet of the company unless an acquiring company pays for them and records them as goodwill.
  • Your company launched a major advertising campaign.All the work is done in January and the cost comes to around 25 lakhs. The accountants may now decide that the benefit from this ad campaign will benefit the company for 2 years . So they will record an expense of 12.50 lakhs in the first year and show the balance 12.50 lakhs as ‘prepaid asset’. The value of 12.50 lakhs  prepaid asset is actually an estimate since the company may receive the benefit of ad campaign for several years or the ad may not click at all !

Now it’s time to move on to the  other side of the balance sheet where we have two separate components to discuss- Liabilities and Equity.More about that in our next lesson.

have a nice day !

You may like these posts:

  1. Balance sheet : what is it?
  2. The components of financial statements
  3. The Income statement :Understanding Depreciation

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