The basic accounting equation is Assets equals Liabilities plus Equity i.e. Assets = Liabilities + Equity.
But then:
You can easily mistake asset and equity as meaning the same thing if you are not well-grounded in accounting. From my experience, people tend to think asset and equity represent the owner or shareholder’s interest in the business.
But then, this is not so.
In this article, I will walk you through the difference between asset and equity. I will also show you how both assets and equity are treated in any entity’s financial statement.
Assets Vs Equity: What Is The Difference Between Asset And Equity?
We’ll consider the difference between asset and equity from the perspectives of the definition, relationship, depreciation, reporting, nature, and relevance to the business.
Definition:
Asset means the resources owned and controlled by an entity as a result of a past event. Such ownership is expected to bring forth future economic inflows to the entity.
On the other hand, equity is what remains after all liabilities have been paid. This means assets are resources while equity refers to the interest of the owners in a business.
Relationship:
The higher the value of a company’s asset and the lower its liabilities like bank loans, accounts payable, bank overdraft the higher the value of the entity’s equity.
For instance, if an entity decides to fold up, and the entity’s assets are N40 million, liabilities N35 million. The remnant to be shared amongst the shareholders would be N5 million but in the case where the value of assets is N100 million, the shareholders will have N60 million to share amongst themselves.
Reporting:
Assets are usually reported at fair value, this could either be of book or market value. On the other hand, Equity is always recorded at book value.
Relevance To The Business:
Assets are needed to generate revenue. Every company need assets that are relevant to its primary business in order to make money from its ordinary business. However, a company can purchase assets only when the owners contribute funds in form of equity to the business.
And yes, you’re right:
The entity can purchase assets with liabilities like bank loans but institutions will only lend money to an entity with skin in the game.
Nature:
Assets are either of the following, Current assets like cash, cash and cash equivalent, Non-current assets like buildings, furniture or Intangibles like copyright, patents. Equity, on the other hand, has no broad classifications, they all exist as equity, examples are ordinary share capital, retained earnings etcetera.
Depreciation:
Depreciation is an expense that is charged on assets. Depreciation is a systematic reduction in the value of an asset until it becomes zero or almost negligible. Assets suffer depreciation but equity is never subjected to depreciation.
On the other hand:
It is equally noteworthy that the efficient utilization of assets funded by shareholders’ funds (equity) to generate a higher profit which is subsequently reinvested in the company will influence an increase in the entity’s equity value i.e. retained earnings.
It will also result in an increase in cash or cash and cash equivalents (asset).
Also where an entity has no liabilities then the value of its assets will be the same as the value of equity i.e. Assets = Equity, since Liabilities is Zero.
Going forward, the differences between assets and equity should not remain a mystery to you anymore.