Assets, Liabilities, Income, Expenditure

Assets, Liabilities, Income, Expenditure – These are the most common terms one comes across frequently when dealing with Finance. These four form the pillars of Personal Finance. 

 

Why these are pillars? All transactions (in money or money’s worth) that happen fall under one of these four categories.

Why is it important? A payment for purchase of a motor car would be an asset where as payment for fuel for the vehicle would be an expense. Similarly, a deposit received for letting out an apartment is a liability but the rent received for letting out the same apartment is an income. It is therefore important to identify & distinguish the nature of payments & receipts.

 

Assets 

 

 In simple words you can call something an asset if it gives you a benefit over a long period of time, normally more than a year. A sofa set at your home, an apartment which you own, would qualify as assets. Also, any amount which you expect to get in future (invoice raised on client by a business, but amount still outstanding) or any amount given to someone which is returnable (Bank FD, loan to friend, excess tax paid to Government) also qualify as an asset. Similarly, any amount invested by a businessman in his own business as a proprietor or as a partner would also be an asset. There are certain assets which are intangible. Example goodwill.

Assets are broadly categorised into Current Assets, Fixed Assets & Investments. As per this categorisation cash in hand, cash at bank and any asset due for realisation within one year would be Current Assets. Any financial Asset would be an Investment. And assets such as apartment, vehicle, furniture, etc would be Fixed Assets.

In the case of businesses, as a matter of standardisation and in some cases as required by law, assets can be grouped into:

Fixed Assets comprising of: Immovable Assets (land, building, shop, apartment, etc), & Movable Assets (furniture, equipment, vehicle, jewellery, etc), Intangible Assets (Goodwill, patent, copyright)

Investments (Bank deposits, shares, mutual funds, investment in business)

Loan & Advances (Loan to friend, tax refund due, advance paid to builder to buy an apartment)

Current Assets - Includes cash at bank, cash in hand, & any other asset that is realisable within one year

Others – Residual category

 

Liabilities

 A liability is a debt or an obligation which a person owes to another. In accounting language, a liability is opposite of an asset. For instance, a bank deposit is an asset for an investor, but the same deposit becomes a liability for the bank, because the bank has to repay the depositor the deposit amount after the tenure of the deposit. Similarly, a loan taken from any one (including a bank), amount due to a supplier of an item which is outstanding, salary or any other expenses such as electricity, telephone bill, etc payable by a business organisation at the end of the month, taxes due to the government, would all be liabilities.

For a business organisation, amount invested by the owners of the business such as proprietor, partners, shareholders, etc would be liabilities. Also, since the profit earned by the business, after paying of all expenses & taxes, would also belong to the owners, hence liability to the business.

As a matter of standardisation and sometimes as required by law, liabilities can be grouped into:

Owners’ Funds (Equity capital, Reserves, etc)

Secured & Unsecured Loans (loans taken from banks, financial institutions & others)

Current Liabilities (amount due to suppliers, expenses payable, etc)

 

Income 

 The word income is normally associated with the word earn. Any receipt of money or money’s equal that is earned is income.

As per the primary laws of economics all income would fit into one of the four categories - Profit, Wage/Salary, Interest or Rent.

Profit means any earning made out of investment made in business. It would include profit earned by a sole proprietary business person, share of profit from a partnership firm. If one treats shareholding in a company as owning a part of that business, dividend earned out of that could be categorised as profit. Normally profit is not fixed & tends to vary from period to period.

Wage / Salary means any earning made in return for physical & mental input. Daily earning by a migrant worker / farm worker, a weekly earning by a factory worker, a software engineer’s monthly salary would fall under the head Salary / Wage. Wage would include any receipt linked to a person’s Wage / Salary such as allowance, Leave Salary, Gratuity, Pension, Family Pension. Earnings by a professional such as lawyer, doctor or an architect too would fall under the category of salary / wages.

Interest is any earning derived out of sum of money given to another for the use of such sum of money by the other person. Any amount received as compensation from a bank or finance company for deposit placed with them, from a friend for a loan given to them, from corporations or governments for Bonds issued by them, would all be interest income.

Rent is any earning derived when one lets out ones property to another for a limited purpose whether regularly or on a one time basis. I can let out an apartment I own to a friend who requires it for 3 months and he agrees to compensate for the use by paying me a rent. Or if you have friends visiting you for a week you can rent a vehicle for taking them out by paying the car rental company. A person can rent an oxygen cylinder if he has got a medical condition and is not sure whether it would work for him.

 

Expenditure

The word expenditure is associated with the word incur. Having understood income, it is much easier to understand expenditure. An expenditure is an exact opposite of an income. Technically, any outflow of money or money’s worth that does not have any lasting benefit and that which does not reduce any liability is an expense. So fuel expenses for a vehicle, rent paid for occupying an apartment or office, utility expenses such as electricity & water charges, any expense incurred by a business person on their staff including salaries, staff welfare, etc., children’s education fees paid would all be classified as expenditure.

Expenses can be fixed or variable expenses. Specific amount paid regularly by way of rent or regular salary paid to staff by a business man and such similar expenses which more or less remain constant irrespective of the situation, would be fixed expenses whereas fuel for vehicle (which would depend on the usage of the vehicle),  or any such expenses that does not remain constant over a period of time would be variable expenses.

Expenses can also be classified as cash expenses & non cash expenses. A very good example of non-cash expense would be depreciation or amortisation. When an equipment is purchased, the effective life of the equipment is estimated. The scrap value of the equipment at the end of the life is also estimated. The difference between the cost & scrap value is spread over the life of the equipment and written off as an expense. This write off is called depreciation or amortisation. Cash outflow is incurred only once, at the time of purchase of the equipment, but the expense is incurred proportionately over a period of the life time of the asset, hence non-cash expenses.

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