Two seemingly simple words, Assets and Liabilities have had many different meanings over the centuries, but these popular terms are still commonly but misunderstood. Understanding the basic concepts of assets and liabilities is a step towards making better financial decisions.
Q. How will this help in budgeting?
Good question aspiring MoneyGeek. Budgeting is planning for the for future income and expenses to meet your financial goals. In budgeting we need to know what is an asset (valuable) and what will be a liability (drain on our finances).
What are the different definitions of assets and liabilities?
|Simple Search||A useful or valuable thing or person||A person or thing whose presence or behaviour is likely to put one at a disadvantage|
The state of being liable.
|Australian Accounting Standards Boards (AASB)|
What is an asset and what is a liability?
From looking at these three different sources; the definition of Assets and Liabilities can be seen and determined differently. When you’re purchasing an asset you want to be able to fully control it, it should come from a past transaction and lastly, the most important; it should provide some economic benefit. Examples of assets are:
- Investment properties
Notice in the list, I did not include personal cars, boats or Televisions or others as assets. Why? Well they do not provide an economic benefit to you. They do not give income to you such as the assets listed above.
To own these items, you pay money for their upkeep and maintaining the appearance and in return, well there is no return, because they do not provide income.
Q. But my car allows me to drive to and from work, why is it not an asset?
A car can be considered a medium between you and work. It assists you as an expense to get you to work. It is you that will work, by typing on the keyboard, hammering a nail or whatever else. The assets listed above earn their own income regardless of what happens. However a car only depreciates in value.
Q. What do I call them then, if not an asset?
Well it is easy to call them a liability because they fit the criteria of expenses in the future, obliged to make repayments and also you purchased the transaction in the past. So it can be easily seen as a liability. You typically cannot borrow against the value of a car or boat as they do not hold an economic value.
Q. So why do sales man call the car, house, boat an asset?
Liabilities still have value – simply a value that is expected to continue to fall or where the cost to maintain is more than what is expected in a possible sale. You don’t want to purchase a liability but it is easy to wrap a liability in an asset coating. The value that the salesman attached is simply the lifestyle or personal value that another person places on that item.
Another term we can use for liabilities in the case of cars, boats, Televisions is ‘Doodads’. Everyone has doodads; you, your family, neighbours everyone does including the MoneyGeeks! Some doodads are useful and helpful, while others are used once and proceed to collect dust.
“You always want what you can’t have; but when you get it do you really want it?” This quote is especially true for Doodads. How many times have you purchased something only to not use it. I have done this and I am sure you have as well. Why does this happen? Through the power of advertising and marketing as they reach out to our supposed needs and wants and also because we see others with the same product/item, looking cool and we want some of that action.
This brings me to my last point, just because a person has an expensive looking car, doodad or fancy house does not automatically make that person rich or wealthy. It is the perception that we have that an expensive car will equal a rich person. In some cases it could be true. While in other cases, that person could just be in debt, mountains of debt. We should not sacrifice our money or get deeper into debt just to satisfy our ego of looking good. If you save your money and invest it into real assets and not just Doodads then the wealth will flow to you and you can buy as many doodads as you wish as you will not be putting yourself into debt.
Remember, what an asset really is and what it can do for you. If you can differentiate the difference between an asset and a liability, you will be creating wealth before you know it.
Stay classy, see you for the next adventure.
About the Author – Damian Ison
Damian is studying a Bachelor of Commerce (BCom), Accounting at the University of Newcastle and has an interest in helping people find ways to save money and build wealth!