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Chapter 2: Problem 8

Define an asset. Define a liability. How can one firm's asset be another firm's liability?

Short Answer

Expert verified
An asset is a resource with economic value that a firm owns or controls, expected to provide future benefit, while a liability is an obligation that arises from past transactions, usually expected to decrease assets or increase another liability in the future. One firm's asset could be another firm's liability in cases like loans and accounts receivables/payables.

Step by step solution

01

Defining Asset

An Asset is any resource owned or controlled by an individual or a business with the expectations that it will provide future benefit. Assets are usually expected to contribute to future cash inflows or decrease future cash outflows. Some examples include cash, land, buildings, equipment, and goodwill.
02

Defining Liability

A Liability is an obligation of an individual or a business arising from past transactions or events. Liabilities usually result in cash outflow or a decrease in assets. Examples include loans, accounts payable, mortgages, deferred revenues, and accrued expenses.
03

Asset of one firm as Liability for another

In the business world, it's common for one company's liability to be another's asset. For example, if a company takes a loan from a bank, that loan is a liability for the company (as it needs to be repaid), but an asset for the bank as it will be paid back, usually with interest. Another example could be accounts receivable (an asset) for one company is accounts payable (a liability) for another firm from which it has purchased goods or services.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Asset Definition
In the world of accounting, an **Asset** represents resources that are owned or controlled by an individual or business, and they are expected to provide future economic benefits. These benefits come in the form of cash inflows or the minimization of cash outflows. Assets are vital as they are the building blocks of a company's financial health. Here are some common forms of assets:
  • **Cash:** The most liquid form of asset, ready for use in transactions.
  • **Land:** Property owned by a business which appreciates over time.
  • **Buildings:** Structures used for operational purposes.
  • **Equipment:** Machinery or tools used in the production of goods and services.
  • **Goodwill:** An intangible asset representing the value of a company's brand and customer relationships.
A deeper understanding of assets helps in analyzing how well a company is positioned to generate returns from its investments.
Liability Definition
When discussing **Liabilities**, we refer to an organization's obligations that arise from past events or transactions. Liabilities are future sacrifices of economic benefits that the entity is obliged to make. These often lead to cash outflows. Some common examples include:
  • **Loans:** Borrowed money that needs repayment.
  • **Accounts Payable:** Money owed to suppliers for goods or services received.
  • **Mortgages:** A specific type of loan taken on real estate.
  • **Deferred Revenues:** Money received before goods are delivered or services rendered.
  • **Accrued Expenses:** Incurred but not yet paid expenses.
Understanding liabilities is crucial as it indicates the financial obligations a business must meet, and affects its ability to generate future profits.
Inter-firm Financial Relationships
In business, entities often engage in transactions that create symbiotic financial relationships. These interrelationships can manifest through one company's assets being another company's liabilities.
For example, consider a loan scenario where:
  • A business borrows money from a bank; here, the borrowed amount is a **liability** for the business, as it must repay this amount in the future.
  • For the bank, however, this loan is an **asset**, as the business has an obligation to repay the borrowed amount, usually with interest, thus generating future cash inflows for the bank.
Another common occurrence involves trade between firms:
  • When one firm sells goods on credit, the sales become **accounts receivable** for the selling firm, considered an asset as it represents expected cash inflow.
  • Conversely, the purchasing firm records it as **accounts payable**, a liability since it indicates a future cash outflow to settle the debt.
These financial dynamics are foundational to understanding how companies interact economically and maintain balance within the financial ecosystem.

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Most popular questions from this chapter

A major asset for most companies is facilities. Use the SEC's EDGAR corporate database (www.sec.gov/edaux/searches.htm.) to locate the 10 -K for Rockwell International dated September \(30,1995,\) and filed on December 21,1995. Required a. Locate and read Item \(2,\) properties (pp. 7-8). For the United States, Europe, South America, and Canada, identify the types of operations for which facilities are maintained. b. Scroll down to the Balance Sheet. Net Property, Plant, and Equipment represents what percentage of total assets on September \(30,1995 ?\)

This assignment is based on a report by the Jenkins Committee. The Jenkins Committee was formed to analyze users' needs in financial reporting and to sug gest improvements in financial reporting, keeping in mind these needs. Required a. Locate Chapter Six of the Jenkins Committee report (located at www. rutgers.edu/Accounting/raw/aicpa/business/chap6.htm), and scroll down to Recommendation \(4 .\) How does the Committee define the core activ- ities of a firm? b. List the core activities for the following corporations:

Sharon's Affairs and Parties (SAAP), a sole proprietorship, engaged in the following transactions in 1999: 1\. SAAP borrowed \(\$ 150,000\) at \(10 \%\) per year to begin operations. 2\. SAAP accrued the first month's interest on the loan. 3\. SAAP accrued the second month's interest. 4\. SAAP paid the interest due 5\. Sharon loaned SAAP \(\$ 10,000\) at \(24 \%\) interest per year 6\. SAAP accrued interest for the next month on both loans. 7\. SAAP paid the accrued interest. 8\. SAAP repaid Sharon's loan, along with a loan "cancellation" fee of \(\$ 2,500\). 9\. SAAP accrued interest for the next month. 10\. SAAP repaid the original loan, along with the accrued interest. Required Record these transactions, using the accounting equation.

Refer to the T-shirt business first described in Chapter \(1,\) "Financial Accounting and Its Environment."The firm now has a small store near the football stadium to display and sell various sporting goods. During the first week that the shop is open, the following events occur. Should they be recorded in the financial statements of the firm? Why or why not? a. A famous football player gives a signed football to the store owner's daughter. b. The firm received a bill from the Public Service Co. for gas and electricity used by the prior tenants in the store. c. The owner bought three lottery tickets for \(\$ 6\) d. One of the three lottery tickets won \(\$ 150 .\) (In this case, assume that you did not originally record the purchase of the tickets and that the owner did not want to record the winnings.) e. The owner learned that the Super Bowl will be held at the nearby stadium in three years.

The Western Fittings Corporation began business on July \(1,1999 .\) The following transactions occurred during its first six months: 1\. Three individuals each invested \(\$ 30,000\) in exchange for capital stock. 2\. One year's rent was paid for \(\$ 12,000\) on July 1 3\. On August 1, several pieces of property, plant, and equipment were purchased for \(\$ 75,000\) on account. 4\. During the six months, clothing, boots, and accessories were purchased for \(\$ 60,000\) cash. 5\. The corporation had sales revenue of \(\$ 85,000\), of which \(\$ 35,000\) has not yet been collected in cash. 6\. The cost of the clothing, boots, and accessories sold in item 5 was \(\$ 55,250\). 7\. Employees were paid \(\$ 24,000\) in wages. 8\. The corporation paid utilities and telephone expenses of \(\$ 5,000\). Required a. Analyze and record these transactions using the basic accounting equation. b. Record the following adjustments for the six months ended December 31 1999: rent expense and depreciation expense. Assume a 10 -year life and zero residual value. c. What is the net income (loss) for the six months ended December \(31,1999 ?\)
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