Accounting: The Language of Business - Vol. 2 (Intermediate: Part 65)

Between a tyrant and a prince there is this single or chief difference, that the latter obeys the law and rules the people by its dictates, accounting himself as but their servant.

John of Salisbury

Statements of Financial Position and Cash Flows and the Annual Report (Part C)

by

Charles Lamson

Assets 

As indicated in Exhibit 6.1, from Part 64 and reintroduced below, assets are generally subdivided on the balance sheet as current assets; long-term investments; property, plant, and equipment; intangible assets; and other assets.

EXHIBIT 6.1 Balance Sheet Classifications

Current Assets. Current assets are resources that the firm expects to convert to cash, to use, or to consume within one year or one operating cycle, whichever is longer. The operating cycle is the period of time from the acquisition of goods to the point at which the entity receives cash from the sale of the goods. For example, consider a clothing wholesaler whose operating cycle begins when it purchases clothing inventory. It will then sell the inventory to retailers on credit. The operating cycle is completed when the wholesaler receives payment from its customers.

Current assets primarily include:

• Cash and cash equivalents.

• Short-term investments.

• Accounts receivable.

• Inventory.

• Prepaid expenses.

Cash and cash equivalents include cash (coins, currency, and money orders) and cash equivalents (short-term, highly-liquid investments acquired with three months or less to maturity). Cash equivalents include:

• Commercial paper (i.e., short-term loans receivable from high-quality corporations sold by commercial banks).

• Money market funds.

• U.S. Treasury bills. 

For example, a three-year Treasury instrument acquired with two months to maturity to a cash equivalent.

Short-term investments not classified as cash equivalents are investments in debt or equity securities of other corporations or governmental entities that the entity has the ability and intent to sell within the next year or operating cycle, whichever is longer. For example, an entity would classify 100 shares of Microsoft that it intends to sell within the next year as a short-term investment.

Accounts receivable (also called trade receivables) are amounts owed to the entity resulting from the sale of goods or services to customers on credit. Accounts receivable arise in the normal course of a company's trade or business and do not require a formal written agreement (A note receivable is a receivable supported by a formal agreement that specifies payment terms.) Accounts receivable are measured net of an allowance for estimated bad debts and are classified as current assets because they are usually due within 30 to 60 days. 

Inventory is tangible property that is either (a) held for sale in the ordinary course of business, (b) used as raw materials in the manufacturing process to produce finished goods to be sold in the ordinary course of business, or (c) held as supplies to be currently consumed when providing goods or services. For a small or wholesale business, inventory includes all goods held for resale. In the case of a manufacturing company, inventory is made up of three components: raw materials, work in process, and finished goods. Inventory is classified as a current asset.

Prepaid expenses are assets that arise when expenses are paid before they are incurred. Common examples are prepaid rent and prepaid insurance. Prepaid expenses are typically considered current assets because the benefits associated with these prepayments are usually consumed within a year or operating cycle if longer. However, any portion of the associated benefit that extends beyond the upcoming year is classified as non-current in other assets.

Long-Term Investments. Long-term investments are non-current assets that are not used directly in the operations of the business. Examples are investments in debt and equity securities and investments in land and other property that are not used in operations.

Property, Plant and Equipment. Property, plant, and equipment are tangible, long lived, and used in the production and sale of the company's goods and services. This balance sheet category includes items such as buildings, land, machinery and equipment, office furniture and equipment, and natural resources. With the exception of land (which is depreciated), all property, plant, and equipment is reported on the balance sheet net of accumulative depreciation or depletion.

Intangible assets. Intangible assets are assets that lack physical substance but have economic value due to the rights they confer upon the holder. This classification does not include financial assets. Common examples of intangible assets include trademarks, trade names, broadcast licenses, patents, copyrights, and franchises. Certain intangible assets are reported on the balance sheet net of accumulated amortization, but others are not subject to amortization. Intangible assets that have a definite or finite useful life are amortized whereas those that have an indefinite life are not amortized.

Other Assets. This other assets category includes any non-current asset that does not fall into any of the primary balance sheet classifications. For example, long-term prepaid expenses and land held for resale may be classified as other assets. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 238-239*

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