The difference between assets and liabilities

What are Assets?

An asset is an expenditure that has utility through multiple future accounting periods. If an expenditure does not have such utility, it is instead considered an expense. For example, a company pays its electrical bill. This expenditure covers something (electricity) that only had utility during the billing period, which is a past period; therefore, it is recorded as an expense. Conversely, the company buys a machine, which it expects to use for the next five years. Since this expenditure has utility through multiple future periods, it is recorded as an asset.

What are Liabilities?

A liability is a legally binding obligation payable to another entity. Liabilities are incurred in order to fund the ongoing activities of a business. Examples of liabilities are accounts payable, accrued expenses, wages payable, and taxes payable. These obligations are eventually settled through the transfer of cash or other assets to the other party. They may also be written off through bankruptcy proceedings.

Comparing Assets and Liabilities

The main difference between assets and liabilities is that assets provide a future economic benefit, while liabilities present a future obligation. An indicator of a successful business is one that has a high proportion of assets to liabilities, since this indicates a higher degree of liquidity.

There are several other issues relating to the difference between assets and liabilities, which are as follows:

  • One must also examine the ability of a business to convert an asset into cash within a short period of time. Even if there are far more assets than liabilities, a business cannot pay its liabilities in a timely manner if the assets cannot be converted into cash. This is a particular problem when assets are largely comprised of slow-moving inventory.

  • The aggregate difference between assets and liabilities is equity, which is the net residual ownership of owners in a business.

For an individual, the primary asset may be his or her house. Offsetting this is a mortgage, which is a liability. The difference between the house asset and the mortgage is the equity of the owner in the house.

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