The Recognition of Assets & Liabilities
Companies can engage in a variety of business transactions. Two common types are those that result in the acquisition of assets or those that incur liabilities. Companies must recognize these transactions at specific times, depending on their accounting method. Both of these transaction types will appear on a company's balance sheet.
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Accounting Method
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Cash basis and accrual accounting are the two common recording methods a company can use. Under the cash basis method, a company must recognize assets when they pay cash for the items. Companies only recognize assets when they pay cash. Liabilities do not occur under cash-basis accounting. Accrual accounting records asset and liability transactions when they occur. No cash must change hands for a company to recognize the transaction.
Assets
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A company must record assets by type and the total amount spent to acquire the item. Assets are either current or long term. Current assets last less than 12 months, while long-term assets last longer. For current assets, the total cost paid is the value reports on the balance sheet. Long-term assets can include any freight, shipping or cost required to put the asset in service. Companies can recognize these costs as they occur, recording them in the long-term asset account.
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Liabilities
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Liabilities represent the value a company owes to an external vendor. The value represents any unpaid balance by a business. Like assets, they are either current or long term, meaning companies will recognize the transaction when it occurs. For example, a company purchases materials on credit to produce widgets. Accountants will record a credit to accounts payable, indicating the company owes money in the near future.
Considerations
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Assets and liabilities often have a symbiotic relationship. A company can incur both an asset a liability in one transaction. For example, purchasing inventory on credit will increase both assets and liabilities. The company recognizes this transaction at one time, recording the information in the balance sheet account. Asset accounts decrease when a company uses or disposes of the items. Liability accounts decrease when the company pays off the money owed to a vendor.
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