What is Asset Classification?
Asset classification is a process for systematic segregation of the assets into various groups, based on the nature of the assets, by application of the accounting rules so as to make proper accounting under each group. The groups are later consolidated at the financial statement level for the purpose of reporting.
Asset Classification Criteria
Classification is done based on specific criteria, as explained below.
A) – Based on Duration Held
Classification based on the duration held are explained below:
#1 – Current Assets
These are the assets that are intended to be held in the business for less than one year. These assets are highly liquid and are expected to be realized within one year. Examples of short-term assetsShort-term AssetsShort term assets (also known as current assets) are the assets that are highly liquid in nature and can be easily sold to realize money from the market. They have a maturity of fewer than 12 months and are highly tradable and marketable in nature. include cash, bank balance, inventory, accounts receivableAccounts ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet., marketable securitiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it., etc.
#2 – Long-Term Assets or Fixed Assets
These are the assets that are intended to be held in the business for more than one year. These assets are expected to provide benefits to the business for several years. Examples of long-term assets include fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples. (commonly known as property, plant, and equipmentProperty, Plant, And EquipmentProperty plant and equipment (PP&E) refers to the fixed tangible assets used in business operations by the company for an extended period or many years. Such non-current assets are not purchased frequently, neither these are readily convertible into cash. ), long term investments, trademarks, goodwill, etc.
B) – Based on Physical Existence
Classification of asset is based on the physical existence are explained below:
#1 – Tangible Assets
Tangible assetsTangible AssetsAny physical assets owned by a firm that can be quantified with reasonable ease and are used to carry out its business activities are defined as tangible assets. For example, a company's land, as well as any structures erected on it, furniture, machinery, and equipment. are those assets that have a physical existence, i.e., which are capable of being touched, felt, and seen. Examples of such assets include plant, property and equipment, building, cash, inventory, etc.
#2 – Intangible Assets
Intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. are those kinds of assets that do not exist in physical form. In other words, these assets cannot be touched, felt, or seen. Examples of such assets include patent, license, goodwill, tradename, brand, copyright, etc.
C) – Based on Use
Classification of asset is based on use are explained below:
#1 – Operating Assets
It refers to those assets that are useful in the conduct of the day-to-day operations of a businessOperations Of A BusinessBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.. These assets help in the generation of revenue and are connected with the core business of the organization. Examples of such assets include inventory, accounts receivable, property, plant and equipment, cash, etc.
#2 – Non-Operating Assets
These assets are those who are not required in the conduct of the daily affairs of the business. They do not play any role in revenue generation. Examples of such assets include fixed deposits, marketable securities, idle equipment, idle cash, etc.
#3 – Fixed Assets
These are those assets that are not held for sale. Instead, they are held for the production of goods or provision of services.
#4 – Inventory
It refers to those assets which are held for further sale in the course of business. Thus, for a real estate dealer, a building will amount to inventory, while for other businesses, the same will form part of fixed assets. It is why it depends on the use for which assets are deployed, and the asset cannot be generalized, and instead, it needs to be classified as per its use and other terms.
#5 – Investment Property
These are the properties that are owned, acquired by finance lease, or constructed by an organization for further sub-leaseSub-leaseSublease refers to the arrangement where a person, known as the lessee, leases out the property taken on lease from the lessor to a third party to exchange periodic rentals. by way of an operating lease to other parties.
#6 – Assets Held for Sale
It refers to those assets which are intended to be sold (other than in the course of business) in the present state and condition within 12 months. The carrying amountCarrying AmountThe carrying amount or book value of asset is the cost of tangible, intangible assets or liability recorded in the financial statements, net of accumulated depreciation or any impairments or repayments. Accordingly, the carrying amount may differ from the market value of assets. is recovered by way of sale.
#7 – Leased Assets
These are the assets that are given under finance lease to some other person or taken under operating leaseOperating LeaseAn operating lease is a type of lease that allows one party (the lessee), to use an asset held by another party (the lessor) in exchange for rental payments that are less than the asset's economic rights for a particular period and without transferring any ownership rights at the end of the lease term. from some other person.
It is essential to properly classify the assets in the financial statementsThe Assets In The Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels., or otherwise, the financial statements may be misleading. Let us consider an example wherein a current asset is wrongly classified as a non-current assetNon-current AssetNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark.. It will result in an incorrect representation of working capital as the same takes into account current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.. Also, asset classification is necessary to understand which assets help in revenue generation and which do not make any contribution. It also helps to identify the solvency of a businessSolvency Of A BusinessSolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease.. Thus, for financial parameters to be correct, the classification must be correct.
This article has been a guide to Asset Classification. Here we discuss the classification of assets is done on parameters that include Based on Duration Held, Based on Physical Existence and Based on Use. You can learn more about Corporate Finance from the following articles –