Challenges in Measuring Assets, Liabilities & Equities

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  • 0:04 How We Count Matters
  • 0:36 Problems with Assets
  • 2:03 Problems with Liabilities
  • 2:43 Problems with Equity
  • 3:26 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.

While it's pretty easy to figure out what is an asset and what is a liability, it is quite a bit harder to determine just how much each is worth. In this lesson, we look at the challenges of measurement in accounting.

How We Count Matters

One of the fundamental assumptions of the business world is that everything can be assigned value. For example, chances are that a greater value is placed on the computer or smartphone that you're reading this on than the bottle of water that you're drinking. However, figuring out just how to measure certain kinds of value can be quite a challenge for accountants. In this lesson, we're going to look at the difficulties that come with measuring assets, liabilities, and equity. Along the way, we'll look at what happens when companies fail to measure their assets properly.

Problems with Assets

Assets are those things owned by a company that can be used to meet debts. This doesn't always have to be physical materials. Promises from other companies are also assets, as are contracts that allow a company to pursue a particular line of business. For example, a contract letting a company be the sole entity that can operate a gold mine is an asset, even if the company doesn't own the mine itself.

However, there are a number of issues that emerge when we try to measure assets. First of all, different assets can have different values to different people. Take art, for example. Determining the value of a piece of art is a very subjective process. We need only look at the auctions where art is often sold to see this. Chances are that the people bidding can afford practically any price, but they only place so much value on a given piece. A painting may be purchased for 18 million dollars and be represented as an 18-million-dollar asset. However, if no one else is willing to spend that for the painting, its value is inflated.

Meanwhile, the prices of assets can change over time. Very famously, this happened with the price of tulips in 1637. In an event known now as tulip mania, the price of the flower skyrocketed to 10 times the average annual wage. Obviously, a tulip is only worth a few dollars today, so someone who put their family savings in tulips wanting to be forever rich would be sorely disappointed.

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