Each week, ‘Accounting Tips Tuesday’, brought to you by Zoho Books, presents articles that fit into one of two categories. First, the theory behind basic, and even not so basic, accounting concepts with practical applications including the old ‘debits and credits’ appropriate to the situation.
Second, we will go beyond the practical theory and actually cover fundamental software use in the proper recording of these types of transactions using Zoho Books.
Today's article begins a new mini-series expanding upon our Accounting 101 concepts and dives deeper into the 'Assets' section of the Balance Sheet.
While certain articles in this mini-series will make use of Zoho Books, the concepts within these articles apply regardless of the accounting software you are using.
Assets encompass a broad expanse of things a company owns; in some ways these constitute the various resources a business uses (or holds for use) over time. It’s easy to think of some things as assets, your cash and investments (savings, money-market accounts, etc.) are clearly assets. It’s also easy to view your assets like the building and property you own, the vehicles and equipment as well as the inventory you have in stock. But not every asset is as 'visible', and not every asset is valued the way you might think it should be. In this mini-series we will look at each of the major asset categories, with practical examples of each, and also look at how to post and record adjustments to those assets over their lifetime.
As I mentioned above, some assets may not seem so obvious; this might include things like your Accounts Receivable for sales you have made but for which you have not yet collected, which are assets too, as are your prepaid items. If you prepay an expense, like a year’s worth of insurance, that prepayment is an asset which should be recorded as an asset account called Prepaid Insurance (or at the very least Prepaid Expenses which may include other prepaid expenses as well).
We will look at the various other kinds and aspects of assets in this mini-series, but today we are going to start our new mini-series by looking at some of the fundamental concepts associated with ‘accounting for assets’.
Cost Basis and Conservatism
The assets of a business are always recorded at their original cost (book value), and even though the fair market value of an asset may increase, the original value is not increased for that asset, something known as ‘cost basis.’ Although this principle means that asset values are not generally increased, they typically decrease in value as a result of a principle known as ‘conservatism.’ While cost basis means that assets are not reported at more than their original cost, principles of conservatism generally require assets to be reported at less than their original cost over time.
In the example below we purchased a new ‘dongle die’ for $1000.00 and paid cash (in the form of a check) from our Bank of Trust account to make the purchase.
Asset Accounting Part 1 Figure 1
Depreciation and Amortization
Depreciation is an accounting concept in which the value of some tangible assets are reduced in accordance with the basic accounting principle of ‘matching’. Since many assets, like equipment have a life expectancy associated with their usefulness, such assets inherently become less valuable over time, and ultimately obsolete. Depreciation strives to ‘match’ the reported value of the assets to their practical worth. In order to accomplish this, depreciation is credited against the asset on the Balance Sheet and debited to Depreciation Expense on the Income Statement at various times (but at least annually) over the life of the asset.
In the case of the Dongle-die we purchased above we might expect the die to have a 5-year life expectancy so we would tend to depreciate the die out over the full five-years (at 20% of the original cost per year). I should note that depreciation methods vary from both ‘book’ reporting and ‘tax’ reporting, we are making some very basic assumptions for purposes of this article. So, based upon these factors, our depreciation General Ledger entries at the end of the first year would appear as:
Asset Accounting Part 1 Figure 2
Since assets of this nature are reported on the Balance Sheet at their cost minus the amounts already allocated (accumulated depreciation) to the Income Statement as Depreciation Expense, it helps if we look at a journal for our Dongle Die Asset; in this case we would see something like:
Asset Accounting Part 1 Figure 3
So even though you paid $1000.00 for the Dongle Die when you bought it, at the end of the first year, the Dongle Die has a carrying amount of just $800.00 (the balance shown above).
Another asset of importance, when you own it, is ‘land’. Land isn’t depreciated or appreciated during the time you hold it as an asset. This means that while it may well have a much higher market value in today’s real world as far as your Balance Sheet is concerned, it is still valued at exactly the same thing as you acquired it for initially.
One might say that ‘amortization is to intangible assets’ as ‘depreciation is to tangible assets.’ Amortization is the allocation to expense of the cost of an intangible asset. We will look at some examples of these in future articles.
Until next time, "may all your assets appreciate."