There is no more fundamental concept in accounting than assets. Assets, or economic resources, are the lifeblood of both business enterprises and not-for-profit organizations. Without assets—to exchange for, combine with, or transform into other assets—those entities would have no reason to exist. Economic resources or assets and changes in them are central to the existence and operations of an individual entity. Both business enterprises and not-for-profit organizations are in essence resource or asset processors, and a resource’s capacity to be exchanged for cash or other resources or to be combined with other resources to produce needed or desired scarce goods or services gives it utility and value (future economic benefit) to an entity.
Since resources or assets confer their benefits on an enterprise by being exchanged, used, or otherwise invested, changes in resources or assets are the purpose, the means, and the result of an enterprise’s operations, and a business enterprise exists primarily to acquire, use, produce, and distribute resources. [Concepts Statement 6, paragraphs 11 and 15]
Because the concept of assets is so fundamental, one would think that the issue of what is or is not an asset would have been settled long ago. All accountants claim to know an asset when they see one, yet differences of opinion arise about whether some items called assets are assets at all and should be included in balance sheets. Those differences of opinion surfaced at the FASB’s first hearings, as already described, and those experiences convinced early Board members that workable definitions of assets and liabilities were imperative.
This post describes the definition of assets, what is and is not an asset [in accordance with FASB Concept Statement 6]. If you want to know more, read on…
The FASB decided on the conceptual primacy of assets and liabilities, meaning that the definitions of all the other elements of financial statements are derived from the definitions of assets and liabilities. Since the definition of assets is critical, Concepts Statement 6 provides a carefully worded definition with three essential facets, adds nine paragraphs explaining the characteristics of assets, and devotes a significant part of Appendix B to the Statement to elaborating the concept of assets. All of those sections are part of the definition of assets.
The definition of assets is in Concept Statement 6, paragraph 25:
Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
Paragraph 26 then describes the trio of characteristics that qualify an item as an asset:
An asset has three essential characteristics: (a) it embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash inflows, (b) a particular entity can obtain the benefit and control others’ access to it, and (c) the transaction or other event giving rise to the entity’s right to or control of the benefit has already occurred.
The definition indicates the appropriate questions to ask in trying to decide whether or not a particular item is an asset:
- Is there a future economic benefit?;
- If so, to which entity does it belong? What made it an asset of that entity?
Future Economic Benefits
Assets commonly are items that also can be characterized as economic resources—the scarce means through which people and other economic units carry out economic activities such as consumption, production, and exchange. All economic resources or assets have “service potential” or “future economic benefit”, the scarce capacity to provide services or benefits to the people or other entities that use or hold them.
Future economic benefit is the essence of an asset (paragraphs 27–31). An asset has the capacity to serve the entity by being exchanged for something else of value to the entity, by being used to produce something of value to the entity, or by being used to settle its liabilities.
The most obvious evidence of future economic benefit is a market price. Anything that is commonly bought and sold has future economic benefit. … Similarly, anything that creditors or others commonly accept in settlement of liabilities has future economic benefit, and anything that is commonly used to produce goods or services, whether tangible or intangible and whether or not it has a market price or is otherwise exchangeable, also has future economic benefit. Incurrence of costs may be significant evidence of acquisition or enhancement of future economic benefits… [Concepts Statement 6, paragraphs 172 and 173].
All value of economic (scarce) goods and services derives ultimately from the utility of consumer’s goods and services, which are used primarily by individuals and families. Their capacity to satisfy human needs or wants creates demand not only for them but also for the producers’ goods and services, used primarily by business enterprises and other producers that provide economic benefit by being used, directly or indirectly, to produce consumers’ goods and services or other producers’ goods and services. Cash is the asset par excellence because of what it can buy.
It can be exchanged for virtually any good or service that is available or it can be saved and exchanged for them in the future (Concepts Statement 3, paragraph 23) and is the medium for settling most liabilities [L. Todd Johnson and Reed K. Storey, Recognition in Financial Statements: Underlying Concepts and Practical Conventions, FASB Research Report (Stamford, CT: Financial Accounting Standards Board, 1982), pp. 91–94]
At least two questions need to be asked about the presence or absence of future economic benefit to determine whether or not an entity has an asset:
- Did the item obtained by an entity truly represent a future economic benefit in the first place?; and
- Does all or any of the future economic benefit to the entity remain at the time the issue of its being an asset is considered?
Concepts Statement 6 says that most assets presently included in financial statements qualify as assets under its definition because they have future economic benefits (paragraph 177). They include cash, accounts and notes receivable, interest and dividends receivable, and investments in the securities of other entities. Inventories of raw materials, work-in-process, and finished goods and productive resources such as property, plant, and equipment also qualify as assets, but some “assets” that have often been described in accounting literature as “deferred costs” or “deferred charges to revenues” either fail to qualify as assets or may perhaps represent assets but cannot reliably be recognized as assets.
Deferred costs that fail to qualify as assets are what-you-may-call-its—deferred costs that do not represent economic resources but are said to be assets “because they must be deferred and matched with future revenues to avoid distorting net income”. For reasons described earlier, the Board firmly rejected the argument that “costs are assets”, and Concepts Statement 6 is explicit:
Although an entity normally incurs costs to acquire or use assets, costs incurred are not themselves assets. The essence of an asset is its future economic benefit rather than whether or not it was acquired at a cost…
… Incurrence of a cost may be evidence that an entity has acquired one or more assets, but it is not conclusive evidence. Costs may be incurred without receiving services or enhanced future economic benefits. Or, entities may obtain assets without incurring costs—for example, from investment in kind by owners or contributions of securities or buildings by donors. The ultimate evidence of the existence of assets is the future economic benefit, not the costs incurred [paragraphs 179 and 180].
Deferred costs that may or may not represent assets are victims of the pervasive uncertainty in business and economic affairs that often obscures whether or not some items have the capacity to provide future economic benefits to an entity and thus should be recognized as assets.
A question arises whether an item received should be recognized as an asset or as an expense or loss if the value of future benefit obtained is uncertain or even doubtful or if the future benefit may be short-lived or of highly uncertain duration.
Expenditures for research and development, advertising, training, development of new markets, relocation, and goodwill are examples of items for which management’s intent clearly is to obtain or augment future economic benefits but for which there is uncertainty about the extent, if any, to which the expenditures succeeded in creating or increasing future economic benefits. That uncertainty led to FASB Statement No. 2, Accounting for Research and Development Costs, in which the Board for primarily practical reasons required entities to recognize the expenditures as expenses or losses rather than as assets.
If research and development or advertising costs actually result in new or greater future economic benefit, that benefit qualifies as an asset. The practical problems are in determining whether future economic benefit is actually present and in quantifying it, especially if realization of benefits is far down the road, or perhaps never [This paragraph paraphrases paragraphs 44, 45, and 173 of Concepts Statement 6 and briefly summarizes the conclusions of FASB Statement No. 2, Accounting for Research and Development Costs, whose development raised questions that helped Board members decide that a definition of assets was essential].
Services provided by other entities can be assets of an entity only momentarily as they are received and used, and they commonly are recognized as expenses when received, but the right to receive services for specified or determinable future periods qualifies as an asset.
Control by a Particular Entity
The definition defines assets in relation to specific entities. An asset is an asset of some entity. No asset can simultaneously be an asset of more than one entity, although some physical assets may provide future economic benefits to two or more entities at the same time. That is, some assets comprise separable bundles of benefits that may be unbundled and held simultaneously by two or more entities so that each has an asset. For example, a building may provide future economic benefits to its owner, to an entity that leases space in it, and to an entity that holds a mortgage on it. Each has an interest in a different aspect of the same building, and each expects to receive cash flows from having one or more of the bundles of benefits.
An entity must control an item’s future economic benefit to be able to consider the item as its asset. To enjoy an asset’s benefits, an entity generally must be in a position to deny or regulate access to that benefit by others, for example, by permitting access only at a price. Thus, an asset of an entity is the future economic benefit that the entity can control and thus can, within limits set by the nature of the benefit or the entity’s right to it, use as it pleases. The entity having an asset is the one that can exchange it, use it to produce goods or services, exact a price for others’ use of it, use it to settle liabilities, hold it, or perhaps distribute it to owners [Concepts Statement 6, paragraph 184].
An entity usually gains the ability to control an asset’s future economic benefits through a legal right. However, an entity still may have an asset without having an enforceable legal right to it if it can obtain and control the benefit some other way, for example, by maintaining exclusive access to the asset’s benefits by keeping secret a formula or process.
Occurrence of a Past Transaction Or Event
Items become assets of an entity as the result of transactions or other events or circumstances that have already occurred. An entity has an asset only if it has the present ability to obtain that asset’s future economic benefits. If an entity anticipates that it may in the future control an item’s future economic benefits but as yet does not have that control, it cannot claim that item as its asset because the transaction, other event, or circumstance conferring that control has not yet occurred.
Since the transaction or event giving rise to the entity’s right to the future economic benefit must already have occurred, the definition excludes from assets items that may in the future become an entity’s assets but have not yet become its assets.
An entity has no asset for a particular future economic benefit if the transactions or events that give it access to and control of the benefit are yet in the future [Concepts Statement 6, paragraph 191].
Similarly, once acquired, an asset continues as an asset of an entity as long as the transactions, other events, or circumstances that use up or destroy its future economic benefit or deprive the entity of its control are in the future.