Asset and Liability Recognition

What are Assets and Liabilities?

An asset is a resource owned or controlled by the business. It is expected to produce future economic benefit: inventory to be sold at a profit, for example.

A liability is an obligation to transfer assets in the future because of a past event. An example is the transfer of monies to discharge the obligation to pay for product delivered by a supplier. An example of the non-cash discharge of a liability is when product or service is owed to a customer, typically when they have paid in advance.

If assets and liabilities do not meet the recognition criteria, they are not recorded and are referred to as “off balance sheet”.

If future economic benefit is uncertain then the conservatism principle means the asset should not be recognized. Marketing expenditures (for brand development) are typically treated as expenses rather than assets because the existence of a stream of future benefits is uncertain compared to the inventory asset, for example. Brands (developed by years of marketing and advertising spend) are often “off balance sheet” even though they exist and have value. Only when brands are externally acquired (often as part of an M&A transaction) will they appear on the balance sheet of the buyer, at historical cost.

Liabilities are most commonly unrecognized when because the associated assets are not controlled (leased assets, for example, covered in a later chapter) or when their existence is very uncertain (such as a litigation law suit).