Assets and liabilities

Assets can be defined as the properties, machinery, investments and cash owned by a business and which are used to achieve objectives. Thus, assets are the resources owned by a business. They are classified as fixed assets and current assets. Fixed assets are normally those which the business intends to hold for more than one year and which are not intended for resale. They are the resources the business needs to function, but they may also include investments in other firms. The conventional order for listing fixed assets begins with the most illiquid, that is the assets which is most difficult to turn into cash without loss of value and ends with the most liquid asset, i.e. the one most easily turned into cash without loss of value. This order also tends to reflect the life of an asset within a business. In normal circumstances land and buildings would be the last assets to be sold if the business went bankrupt or into liquidation. It is therefore classified as the most fixed, i.e the least liquid, asset. Cash is changing all the time, and is therefore the least fixed, i.e the most liquid, asset. An outline listing of fixed assets can be given as:

1. Freehold land and buildings. The word “freehold” means that the owner has absolute rights over the land and does not have to pay rent for it.

2. Leasehold land and buildings. A lease is a legal agreement between the owner of a property, the lessor, and another person, the lessee, that the lessee shall have the use of that property for a specified period of time. The time clause means that a leasehold is both less fixed in terms of ownership than freehold property and also more difficult to sell without loss of value.

3. Plant, machinery and equipment. After buildings a business needs the physical equipment to produce the good or service. Without them the business could not function, so they are only marginally less fixed than the buildings.

4. Vehicles. A van or car is both more flexible in use and has a shorter working life than a piece of machinery or a factory. It therefore ranks as less fixed than both.

5. Goodwill, patents and trademarks. These are easy to define butmore difficult to value.

· Goodwill is the favour and prestige a business enjoys which adds value to it beyond the value of its physical assets. Unfortunately there is no way of knowing the value of goodwill until the business is sold. To ignore it totally would be to deny an asset of the business. Estimates of goodwill should be conservative.

· Patents are legal documents securing to an inventor the exclusive right to make or sell an invention. Once an inventor has secured the letters patent to an invention they may license other people to use the invention. This is a legal agreement and the inventor will receive royalties in payment for the licence. Patents usually refer to the invention of machinery. In the media - books, films, records, videos - and the world of computer software the equivalent protection is copyright. Both patents and copyright attempt to protect the originators of an idea from exploitation by other people

· Trademarks identify a product and help build up consumer loyalty. If you bought a factory manufacturing the well-known Megamints you would want to be able to continue using that name. A successful trademark is the end result of good market­ing and quality control. It ensures continuing sales.

6. Investments. These are not expected to be held beyond the present accounting period. An accounting period usually lasts for one year.

Current assets

Current assets are those which are 'used up' in the day-to-day operations of a business and which can be converted into cash faster and without potential loss of value. Their listing follows the same convention as fixed assets: the most permanent and illiquid are placed first, whilst cash is last. Current assets include stock, debtors and prepayments, cash at bank and cash in hand. Debtors are those businesses which have taken delivery of goods but which have not yet paid for them, in other words, firms to whom the business has granted trade credit.

Liabilities

Strictly speaking a liabilityis a contribution of resources to a business for which a business has to render an account of its use. The formation of a company gives the business a separate legal identity and the people who run the business must, by law, account for the way in which they have used the money entrusted to them. This will include money lent to the business and also money invested in the business by the owners that is shareholder’s funds. Sole traders and partnerships are not subject to the same legal constraints as companies, in that their accounts do not have to be made public, but the accounts of these businesses are treated as if the business is a separate identity from the owner. This has the practical advantage of allowing the owners of the business to keep a clear record of how much money they have invested and therefore of being able to judge the profit/loss position of the business more accurately. In the case of the sole trader the owner's capital would be presented as proprietor's funds. The usual practice is to start with owner's funds, follow this with loans which will not have to be repaid in the current accounting year, then current liabilities.

Date: 2015-12-11; view: 972