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 assets include cash, bank balance, inventory, accounts receivable, marketable securities, 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 assets (commonly known as property, plant, and equipment), 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 assets 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 assets 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.
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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 business. 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-lease 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 amount 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 lease from some other person.
Conclusion
It is essential to properly classify the assets in the financial statements, or otherwise, the financial statements may be misleading. Let us consider an example wherein a current asset is wrongly classified as a non-current asset. It will result in an incorrect representation of working capital as the same takes into account current assets. 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 business. Thus, for financial parameters to be correct, the classification must be correct.
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