The balance sheet is a financial statement that reports various account balances. Companies may combine several items under a single name or report them separately. Nonetheless, they accumulate those accounts to offer a financial picture of operations. The balance sheet is the only financial statement that presents those balances. Similarly, it does not report the information for a period. Instead, it shows them at a specific date.
The balance sheet segregates account balances into several categories. This process is crucial to meet the accounting standard requirements for this statement. Consequently, companies must present the balance sheet by showing three components. These include assets, liabilities, and equity. Furthermore, accounting standards require companies to report asset and liability balances under non-current and current portions.
The definition for non-current and current portions for these elements are similar. Therefore, many users confuse them. Similarly, they wonder what the differences between current assets and current liabilities are. Before discussing those differences, it is crucial to understand each element under the accounting definition.
What is an Asset?
An asset is any resource that a company uses to generate revenues. It includes property, plant, machinery, tools, and equipment used within operations. On top of that, it also consists of cash, inventory, receivables, and similar items. Assets help companies remain in business. Companies generate these from external and internal sources. However, the above does not constitute the definition of assets under accounting.
In accounting, assets are resources owned or controlled by a company. Similarly, these resources must result in an inflow of economic benefits in the future. The definition for assets in accounting includes two parts. The first covers the essence of what may classify under this heading. Essentially, resources owned or controlled by an entity conform to the definition of an asset set by accounting.
In the past, people thought companies must own assets to recognize them. However, this definition also includes resources controlled by the company. Essentially, it considers the substance over the form for elements. The second part of the definition is also crucial in constituting what assets are. If a company cannot expect inflows of economic benefits from a resource, it will not fall under the definition.
Overall, an asset is any resource that provides value to a company. This value can come from sale or through use. Either way, companies use assets to generate revenues as a part of their operations. As mentioned above, companies also segregate those resources into either current or non-current assets. Assets are crucial for companies to compete in the market.
What is a Liability?
A liability represents money owed to third parties that companies must repay in the future. Essentially, it includes debts that companies accumulate from their operations. On top of that, it also consists of finance received from third parties. While liabilities may sound adverse, they are essential to running a company in the long run. Every company accumulates obligations from its operations in some way.
In accounting, the definition of liability differs. It includes any obligations that companies get from past events. Unlike assets, liabilities result in an outflow of economic benefits in the future. This definition of liabilities in accounting also includes two parts. If an obligation does not meet any of these criteria, companies cannot classify it as a liability in the balance sheet.
The above definition requires liabilities to come from past events. Essentially, companies operate in various areas. Consequently, they may accumulate obligations from their activities. If obligations do not come from past events, they will not satisfy the definition. For example, any expected liabilities from the future will not become a part of the balance sheet. Similarly, if there is no obligation to pay, it won’t be a liability.
Similarly, liabilities must result in an outflow of economic benefits in the future. Accounting standards allow companies to recognize an obligation even if they expect those outflows. However, it must be probable or virtually certain. In accounting, liabilities are the opposite of assets. However, they only include debts to third parties and not shareholders.
What are Current and Non-Current Assets and Liabilities?
As stated above, accounting standards require companies to separate assets and liabilities into two portions. This separation occurs undercurrent and non-current headings. Before doing so, however, companies must ensure an account balance meets the definition for each element. For example, companies must first ascertain an item is an asset. Once they do so, they can report it as current or non-current.
The primary difference between current and non-current portions is the timing. Essentially, if this time occurs within 12 months, it will fall under the current portion. For items that last longer than that, the classification will be non-current. These definitions help clarify what each portion constitutes. However, it is crucial to understand both in the context of each element separately.
The current portion of assets includes resources that companies expect to last 12 months. If a company estimates a resource to provide economic inflows within that period, it will fall under the current portion. Usually, these include inventory, cash, receivables, etc. In contrast, for resources that result in inflows after that period, it will become non-current. These primarily consist of fixed assets, such as property, plant, and equipment.
Current liabilities are obligations that companies expect to settle within 12 months. Therefore, the outflows of economic benefits will occur within that period. Usually, these include accounts payable, tax payable, accrued expenses, etc. In contrast, non-current liabilities require a settlement after a year. These consist of loans, leases, and long-term debt. In some cases, current portions of these liabilities also fall under current liabilities.
What is the difference between Current Assets and Current Liabilities?
The term current applies to both assets and liabilities. In some cases, it may cause confusion between users of the financial statements. In both cases, it includes items that last less than 12 months. Any residual balances fall under the non-current portion for each section in the balance sheet. However, both of these are significantly different.
The primary difference between current assets and current liabilities is their underlying section. Current assets include resources that companies own or control. On the other hand, current liabilities are obligations from past events. These definitions set both areas apart based on the essence of each element. These definitions are the same as defined above for assets and liabilities.
On top of that, the difference between current assets and current liabilities is the flow of economic benefits. In the former case, the flow is toward the company. Therefore, current liabilities result in an inflow of benefits. For the latter case, the flow occurs from the company to a third party. Therefore, current liabilities cause an outflow of economic benefits.
The items classified under current assets and current liabilities also differ. As mentioned above, the latter usually include cash, inventory, and accounts receivable. Essentially, it consists of any resources that companies expect to benefit from within 12 months. The examples include accounts payable, accrued expenses, and short-term borrowings. It also contains the current portions of non-current liabilities.
Companies prepare the balance sheet to report various account balances. These balances fall under three elements, assets, liabilities, and equity. For the first two, accounting standards require separating current and non-current portions. The current portion includes any items that last for less than 12 months. The difference between current assets and current liabilities comes from their essence.