In December 2014, the media (see here for example) noted how millions for euro were “off-balance” sheet. According to reports from the Vatican “some hundreds of millions of Euros were tucked away in particular sectional accounts and did not appear on the balance sheet”. So how can this happen, and what does off-balance sheet actually mean?
Let’s go back to basics first. A balance sheet shows assets, liabilities and equity. Assets are essentially something an organisation own’s or has use of like a owner; a liability is a claim against the business. Both must be measurable in monetary terms. So for example, many large firm’s brands have values in $billions put on them, but these are off-balance sheet assets which are off-balance sheet because the value cannot be measured accurately in money terms.
In other cases, such a the Vatican example, assets can be seemingly omitted from the balance sheet. This is of course not a recommended practice. How is this done? Well, it is a little bit more complex than this, but essentially something is omitted from the books of the organization. Remember, now matter how complex an organization is, underneath its accounting system is the good old double entry system of accounting. If a transaction (e.g. bank account) is omitted from the double entry accounts, that’s it, it does not appear on the balance sheet.
In my previous post, I introduced assets. Now let’s see how assets are classified in accounting.
There are two major asset classifications 1) non-current and current, 2) tangible and intangible. Let’s have a brief look at each.
Non-current versus current assets
A non-current assets is one which typically cannot be converted into cash within one year. The classic example of a non-current asset is plant, property and equipment. Current assets normally convert into cash within one year e.g. receivables from customers, inventories. This non-current and current classification is used in the financial statements of most organisations.
Tangible versus intangible assets
This one is a little more tricky to understand, and it is something not normally seen on financial statements. As you might guess, a tangible asset is one which you can see and touch i.e it physically exists. Typically examples are again, plant, property and equipment, but also inventories are a tangible asset. Money due from customers is also arguably a tangible asset, as it does exist as money albeit somewhere outside the business. Intangible assets are those which do not physically exist, but yet have a value. This value may arise from intellectual or legal rights. For example, trademarks, patents, in-house software or knowledge built up through research and development are intangible assets. The accounting standard which governs intangible assets is IAS 38, and it gives some examples:
- computer software
- motion picture films
- customer lists
- mortgage servicing rights
- import quotas
- customer and supplier relationships
- marketing rights.
The next few posts will provide some basic accounting terms and definitions – concentrating mainly on assets.
So what is an asset? If I look at a dictionary, I might see something like “a useful thing” or a “desirable quality”. This may be correct in a general sense, but in accounting we need to get a bit more specific. But before we do that, would you regard something which is useful or desirable as having some value to you? I’ d hope you say yes. Now keep that in mind.
If I look to some accounting rules such as the IASB Framework I get the following:
” An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity”
Let’s break that down:
- It is controlled – does this mean you must own an asset. Simply, no, as you can control something, but not legally own it
- It as a result of past events – this means you bought it or somehow acquired it or rights to use it in the past
- Future economic benefits will flow – this means it will be something which directly or indirectly allows the business to make money. For example, an office building does not sell anything (usually) or deliver goods, but without on the business cannot carry on its work to bring in those economic benefits i.e. cash and profits.
So, going back to the general idea I introduced at the start, if you want a very basic tip to identify an asset, think of it as something of value to a business – a truck, a machine, a building, customers you owe money etc,