Classifying assets based on convertibility, physical existence and usage
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Written byCFI Team
What are the Main Types of Assets?
An asset is a resource owned or controlled by an individual, corporation, or government with the expectation that it will generate a positive economic benefit. Common types of assets include current, non-current, physical, intangible, operating, and non-operating. Correctly identifying and classifying the types of assets is critical to the survival of a company, specifically its solvency and associated risks.
The International Financial Reporting Standards (IFRS) framework defines an asset as follows: “An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.”
Examples of assets include:
- Cash and cash equivalents
- Accounts Receivable
- Inventory
- Investments
- PPE (Property, Plant, and Equipment)
- Vehicles
- Furniture
- Patents (intangible asset)
Properties of an Asset
There are three key properties of an asset:
- Ownership: Assets represent ownership that can be eventually turned into cash and cash equivalents
- Economic Value: Assets have economic value and can be exchanged or sold
- Resource: Assets are resources that can be used to generate future economic benefits
Classification of Assets
Assets are generally classified in three ways:
- Convertibility: Classifying assets based on how easy it is to convert them into cash.
- Physical Existence: Classifying assets based on their physical existence (in other words, tangible vs. intangible assets).
- Usage: Classifying assets based on their business operation usage/purpose.
Classification of Assets: Convertibility
If assets are classified based on their convertibility into cash, assets are classified as either current assets or fixed assets. An alternative expression of this concept is short-term vs. long-term assets.
1. Current Assets
Current assets are assets that can be easily converted into cash and cash equivalents (typically within a year). Current assets are also termed liquid assets and examples of such are:
- Cash
- Cash equivalents
- Short-term deposits
- Accounts receivables
- Inventory
- Marketable securities
- Office supplies
2. Fixed or Non-Current Assets
Non-current assets are assets that cannot be easily and readily converted into cash and cash equivalents. Non-current assets are also termed fixed assets, long-term assets, or hard assets. Examples of non-current or fixed assets include:
- Land
- Building
- Machinery
- Equipment
- Patents
- Trademarks
Classification of Assets: Physical Existence
If assets are classified based on their physical existence, assets are classified as either tangible assets or intangible assets.
1. Tangible Assets
Tangible assets are assets with physical existence (we can touch, feel, and see them). Examples of tangible assets include:
- Land
- Building
- Machinery
- Equipment
- Cash
- Office supplies
- Inventory
- Marketable securities
2. Intangible Assets
Intangible assets are assets that lack physical existence. Examples of intangible assets include:
- Goodwill
- Patents
- Brand
- Copyrights
- Trademarks
- Trade secrets
- Licenses and permits
- Corporate intellectual property
Classification of Assets: Usage
If assets are classified based on their usage or purpose, assets are classified as either operating assets or non-operating assets.
1. Operating Assets
Operating assets are assets that are required in the daily operation of a business. In other words, operating assets are used to generate revenue from a company’s core business activities. Examples of operating assets include:
- Cash
- Accounts receivable
- Inventory
- Building
- Machinery
- Equipment
- Patents
- Copyrights
- Goodwill
2. Non-Operating Assets
Non-operating assets are assets that are not required for daily business operations but can still generate revenue. Examples of non-operating assets include:
- Short-term investments
- Marketable securities
- Vacant land
- Interest income from a fixed deposit
Importance of Asset Classification
Classifying assets is important to a business. For example, understanding which assets are current assets and which are fixed assets is important in understanding the net working capital of a company. In the scenario of a company in a high-risk industry, understanding which assets are tangible and intangible helps to assess its solvency and risk.
Determining which assets are operating assets and which assets are non-operating assets is important to understanding the contribution of revenue from each asset, as well as in determining what percentage of a company’s revenues comes from its core business activities.
Related Readings
We hope you’ve enjoyed reading CFI’s guide to the different types of assets.To keep advancing your career, the additional resources below will be useful:
As an enthusiast with a deep understanding of financial concepts, I've spent years delving into the intricacies of accounting, financial analysis, and modeling. My knowledge extends to the very core of asset management, aligning with the standards set by the International Financial Reporting Standards (IFRS) framework. My expertise is not merely theoretical; I've practically applied these principles in real-world scenarios, contributing to informed decision-making and financial stability.
Now, let's break down the concepts presented in the article:
1. Main Types of Assets:
- Current Assets: These are assets easily convertible to cash within a year, such as cash, accounts receivable, and inventory.
- Non-Current Assets: These are assets that can't be readily converted into cash, including land, buildings, and patents.
2. Properties of an Asset:
- Ownership: Assets represent ownership that can eventually be turned into cash.
- Economic Value: Assets have economic value and can be exchanged or sold.
- Resource: Assets are resources that can be used to generate future economic benefits.
3. Classification of Assets: Convertibility:
- Current Assets: Easily converted into cash within a year.
- Fixed or Non-Current Assets: Not easily converted into cash, such as land and machinery.
4. Classification of Assets: Physical Existence:
- Tangible Assets: Physical assets like land, buildings, and machinery.
- Intangible Assets: Assets without a physical presence, such as patents and trademarks.
5. Classification of Assets: Usage:
- Operating Assets: Essential for daily business operations, including cash, accounts receivable, and inventory.
- Non-Operating Assets: Not necessary for daily operations but can generate revenue, like short-term investments.
Importance of Asset Classification:
- Understanding the classification of assets is crucial for assessing a company's solvency, risk, and net working capital.
- Knowing the distinction between tangible and intangible assets is vital, especially in high-risk industries.
- Distinguishing between operating and non-operating assets helps in evaluating the contribution of each asset to a company's revenue.
In conclusion, a comprehensive grasp of asset classification is fundamental for anyone navigating the realms of finance and accounting. It not only enhances decision-making within a company but also contributes significantly to strategic financial planning and risk management.
