Study: Define Common Asset Accounts

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Slide 1 (:07s): Links to an external site.Welcome to Introduction to Accounting, Preparing for a User’s Perspective.  Define standard asset accounts.  

Slide 2  (1m:04s): Links to an external site.How are assets defined by the FASB?  Assets Links to an external site.are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

This statement comes from the Statement of Financial Accounting Concepts No. 6 Elements of Financial Statements.  In this statement, the FASB Links to an external site.attempted to define the key pieces of what makes up the financial statements, such as assets, liabilities, equity, [investments by owners, distributions to owners], revenues, expenses, [gains, and losses].

This has been reproduced with permission of the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, USA, and is copyrighted by them.

What I want you to do as we go through the definitions of the assets, is see how each of the assets have a probable future economic benefit, how they are controlled by an entity, and how they obtained this asset as a result of a past transaction or event.

If something does not meet all three of these key criteria, it should not be an asset and should be expensed or written off somehow, or should never have been recorded in the first place.

Let’s look at some standard asset accounts and see how they meet this definition.

Slide 3 (:15s): Links to an external site.

 
These are the accounts that we will be talking about.  All of these are assets because they will provide some probable future economic benefit, the entity has obtained or controls them, and they did that through some past transaction or event.  

Slide 4 (:43s): Links to an external site.Before we go too far, let’s make sure you know how to compute the ending balance of a given account.

You can look at it horizontally like you would have learned in a math class in school.  You take whatever you started with, your beginning balance.  You add the increases, take away the decreases, that will give your ending.  (See Horizontal equation format below).

 
Sometimes we look at those formulas in a vertical fashion.  Take the beginning at the top, add the increases, deduct the decreases, and you get your ending [balance as per the vertical equation format above].

Another way of looking at this, which is how accountants tend to do it, is they put the beginning balance on one side, have the increases being added on the same side, decreases on the opposite side, and wind up with the ending balance.  For assets, we will track the normal balance here on the left-hand side.  

Slide 5 (:51s): Links to an external site.We’ll learn about how liabilities and equity track that on the right-hand side.  

 
As you can see here [in the balance sheet equation Links to an external site. diagram above], assets are on the left-hand side of the balance sheet equation; therefore, the beginning balance and increases and ending balance will normally be on the left and the decreases on the right.

Liabilities Links to an external site.and equity Links to an external site., since they are on the right-hand side of this equation, the beginning balance will be on the right-hand side with increases also on the right-hand side and decreases on the left.

Accountants have developed this method over time, because it allows you to do the math a little bit faster by hand, if you put all the increases together, you can add them all up really fast, as opposed to having, increase, decrease, increase, decrease, all on the same column.

They put the decreases on the opposite side just so you can add up all increases together and then in one computation, deduct the total of all the decreases.

We will dig into this later in more detail to show how accountants use these T-accounts Links to an external site. in computing balances.

Slide 6 (1m:35s):  Cash and cash equivalents. Links to an external site.Cash and cash equivalents.  Why is cash an asset?  Cash is an asset because it can provide you a future benefit.  You’ll be able to buy things with this cash.  

Now that cash can be in the form of currency and coin.  Money orders Links to an external site. which are kind of like a check, but the person who paid you already deposited the money with someone like the U.S. Postal Service and then the U.S. Postal Service wrote this money order out to you.  So you are holding these [money orders] and that is cash to you.  

Checks from customers, we assume they’ll actually be able to clear the bank, but we call that cash, and your own bank deposits.  Money that you’ve deposited in the bank is cash to you.

Cash equivalents are not necessarily cash, but they’re close enough that the difference between their value today and when it finally matures into cash, is not expected to change significantly.  

As long as between when you buy this Treasury bill Links to an external site. (the US government has borrowed money from you and then they’re going to pay you within three months of when you bought it) that would be considered a cash equivalent.  

Money market funds where you effectively have invested in a fund that buys very low risk things such as treasury bills [or high-grade corporate bonds].

Your cash is going to increase, meaning you have more of that asset, when your customers pay you, when you sell long-term assets Links to an external site. and receive cash, when you borrow money from lenders and receive cash, or when you issue stock Links to an external site. to your owners and receive cash.  

Now that cash account is going to go down when you pay cash to your suppliers, pay for long-term assets, payoff the lenders that you borrowed from, and when you pay dividends Links to an external site. to your owners.  It could also go down if you buy back your own stock.  But the point is, cash coming in [on the left], cash going out [on the right].  [see the cash account diagram below]

Slide 7 (1m:23s)  Accounts Receivable Links to an external site.Let’s move on to another asset:  Accounts receivable Links to an external site..  If you’re selling to customers and they ask to pay later and you agree to that, you have what’s called an account receivable.  

Account receivable is an asset.  Why, because it will benefit you in the future.  You’ll get cash when they finally do pay, and you obtain control over that by making a sale to this customer, so they agreed to pay you and that was a past transaction.

Your accounts receivable account will increase, when you make sales on account to customers.  These are known as credit sales.  They may also increase if, maybe in the past you wrote it off thinking you would never collect but then all of a sudden, you realized you would [collect], so you’d increase it, and then finally collect. 
Now when they do pay, that’s going to cause your receivables to go down.   You’re going to get the cash, and since you now have the cash, you no longer have the receivable.  There is no future benefit [of the receivable] if they have already paid you.  

When customers pay, receivables go down.  If your customer returns a good that they don’t want, you often will give them, a reduction in the receivable, so they owed you $100, and they say “Oh I didn’t want that [product] anymore” you would reduce the amount they owe you by that $100.  

Sometimes customers simply don’t pay.  In that case, when you have concluded “Hey, this customer will not pay because they’ve gone bankrupt”, then you would write off your bad accounts receivable.  

So that will cause this asset called receivable to go down.  It’s no longer an asset because there is no future benefit.  They’re not paying.  [see the accounts receivable account diagram below]

Slide 8 (:39s):  Inventory Links to an external site.Let’s move on.  

Inventory.  You know what inventory Links to an external site.is.  These are all the products that you plan on selling to your customers.  So your inventory will increase when you buy more inventory, or when you are manufacturing, it’s the direct materials that go into producing the product, the direct labor that goes into producing the product, and all the other overhead costs, and we’ll learn about those later as well.

Your inventory is going to go down if you sell the goods to a customer, so that would be an expense called cost of goods sold Links to an external site..  If the inventory gets destroyed, stolen, or simply becomes obsolete and you throw it away.  

If any of these things happen, then you no longer have an asset called inventory.  It’s not worth anything, therefore, there is no future benefit, and therefore it is no longer an asset.  [see the inventory account diagram below]

Slide 9 (:34s):  Office supplies. Links to an external site.Office supplies.  Office supplies are those products that you have in your business that help you run the business, your post-it notes, your pens, your pencils, paper, things like that.  When you buy those things, your office supplies account goes up, because it’s an asset.   It is going to provide you a future benefit because you can use these things in the future.  They will decrease if you use up the supplies. 

If I go and use all of these pencils, they are now nothing, you no longer have an office supply asset of pencils, they have been decreased.  If they have been destroyed in a fire, or someone stole them, or if they have become obsolete and no longer are useful to you.  [see the office supplies account diagram below]

Slide 10 (:37s):  Prepaid rent Links to an external site.Prepaid rent.  If you pay $12,000 in rent now [December X2] for the next 12 months, this [$12,000] prepayment is an asset to you because it’s going to benefit you in the future because you made some payment in the past [and have not yet received the value for such payment].  

As the following year progresses and you use up that rental prepayment, then, that asset is no longer an asset, it will get reduced as you use it up.  If, for example, you receive a refund of a prepayment, maybe you choose to move out and they say “Well, you prepaid for another five months, we will give you all of that money [$5,000] back, then you no longer have a prepayment because they gave you the cash.  It [prepaid rent] can’t be an asset if they have given you the cash back. 

[Note:  the cash you just received is now an asset, but prepaid rent should be $0 because $7,000 was used up as rent expense and $5,000 was refunded when you moved out].  [see the prepaid rent account diagram below]

Slide 11 (:34s):  Prepaid insurance. Links to an external site. Prepaid insurance.  Same idea.  If you pay now, $600 to insure a car for the next 12 months, it’s an asset until the time expires for that insurance.  Once you’ve passed each month, 1/12 of the $600 [prepaid insurance] will be expensed and decreased.  

Your prepaid insurance increases as you prepay for the future, it decreases as the insurance period expires.  If you cancel your policy, they will give you back cash [for any unused portion] and your prepaid insurance account will go down.

You can’t have prepaid insurance if they’ve refunded you your prepayment.  [see the prepaid insurance account diagram below]

Slide 12 (:18s):  Notes receivable Links to an external site.Notes receivable.  This is when you lend money.  Let’s imagine you’re the lender, if you lend money to this borrower, you would have an asset called a note receivable because they promised to pay you [back] in the future.  

It will decrease if they pay the loan off.  Or maybe you realize that this borrower is never going to pay you and you just write it off.  [see the notes receivable account diagram below]

Slide 13 (:16s):  Warehouse equipment Links to an external site.Warehouse equipment.  These are the things that help you run your warehouse like a forklift.  They increase when you buy warehouse equipment.  They decrease  when you sell the warehouse equipment, or if it gets destroyed or you dispose of the  warehouse equipment.  

Whenever these things happen [sell, destroy, dispose of warehouse equipment] you no longer have an asset, therefore, your asset account needs to decrease. [see the warehouse equipment account diagram below]

Slide 14 (:12s):  Land Links to an external site.Land.  I think land is pretty straightforward.  It increases when you buy land, it decreases when you sell it or the land somehow gets destroyed, like if it fell off into the ocean due to a Tsunami, then  you wouldn’t have land anymore.  It can’t be an asset if you can’t find it anymore.  [see the land account diagram below]

Slide 15 (:26s):  Patent Links to an external site.Patent.  This is a government issued and protected right to a unique design, process or developed species, like a plant, you know, if you have a hybrid plant that you designed genetically, you can have a patent on that and that’s for 20 years.

If you purchase a patent Links to an external site.from another company, then your patents will go up.

The legal fees to register your own patent will be an asset and that will have a benefit of 20 years. 

It will decrease if you sell a patent or if the patent expires.  [see the patent account diagram below]

Slide 16 (:32s):  Trademarks Links to an external site.Trademarks.  Trademark Links to an external site.owners are allowed to protect unique numbers, words, phrases, symbols and designs that distinguish their products or services from others.  So you might see this TM, or this little ®, this is a registered trademark.  You might see the SM for Service Mark.  Product that you sell, it’s a TM.  If it’s a service, then its SM, and if you’ve officially registered, you’ll see that little ® there.

It increases when you buy trademarks or you pay fees to register and it decreases as the trademark expires or you sell it off. [see the trademarks account diagram below]

Slide 17 (:23s):  Copyright Links to an external site.Copyright, the legal right to protect a creative work by authors such as music, writings, and art.  Fees you pay to [obtain a] copyright cause your copyright Links to an external site.account to increase.  

The legal fees paid to successfully defend your copyright, that will increase the value of your copyright.  

Now if you sell it, or if it expires, then your copyright asset decreases.  [see the copyright account diagram below]

Slide 18 (1m:09s):  Goodwill Links to an external site.Goodwill.  Goodwill Links to an external site.like copyrights, patents and trademarks is an intangible asset.  That means you can’t touch it necessarily, it has no tangible substance, but it does have value.  It represents the excess purchase price paid to acquire another business in excess of its net identifiable assets.

Let’s look at an example.  Assume Company B were to purchase Company A’s net identifiable assets, that’s $12 m in assets, less $3 m in liabilities, that would give a net identifiable assets of $9 m.  If Company A were to be sold for $20 m, the excess payment $20 m [purchase price] minus $9 m [market value of net identifiable assets] would be classified as goodwill and could be justified, possibly, by Company A’s reputation or potential synergistic effects.  

Goodwill increases when you purchase other companies in excess of their net [market value of] identifiable assets, that causes goodwill.  Goodwill is reduced when it is impaired, for example when their reputation is significantly damaged, the goodwill should be written down.  Or, if you sell the company to which the goodwill relates, you would have to decrease the goodwill account.  [see the goodwill account diagram below]

Slide 19 (:19s): Links to an external site.That was just a very fast run through of different standard asset accounts that you might come across in this class.  I took that time because we are going to soon start creating a balance sheet and I want you to recognize and I want you to recognize the words of the assets that appear on the balance sheet.