Classification of Assets based on usage (Usage based approach)

Classification of Assets based on usage (Usage based approach)

(Example: For a manufacturing business, Plant & factory will be considered as Operating assets based on usage)

What is Asset?

An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future economic benefit. Assets are reported on a company's balance sheet and are bought or created to increase the value or benefit of the entity's operation. An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses, or improve sales, regardless of whether it's manufacturing equipment or a patent.

For an asset to be present, a company must possess a right to it as of the date of the financial statements i.e. Reporting date. An economic resource is something that is scarce and has the ability to produce economic benefit by generating cash inflows or decreasing cash outflows.

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
• ·         Inventory
• ·         Investments
• ·         PPE (Property, Plant, and Equipment)
• ·         Vehicles
• ·         Furniture
• ·         Patents (intangible asset)
• ·         Stock

Classification of Assets

Assets are generally classified in three ways:

1.    Convertibility: Classifying assets based on how easy it is to convert them into cash. It represents the liquidity of the assets

2.    Physical Existence: Classifying assets based on their physical existence (in other words, tangible vs. intangible assets).

3.    Usage: Classifying assets based on their business operation usage or purpose.

Now here we will discuss our topic after the above background

Classification of Assets based on 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 (assets used in the normal course of business). In other words, operating assets are used to generate revenue from a company’s main business activities. Such assets support companies prime activities Examples of operating assets include:

• ·         Cash
• ·         Stock
• ·         Building
• ·         Machinery
• ·         Equipment
• ·         Patents
• ·         Copyrights
• ·         Goodwill

Non-Operating Assets: Non-operating assets are assets that are not required for daily business operations but can still generate revenue. That means such an asset does not support the companies prime activities. Examples of non-operating assets include:

• ·         Short-term investments
• ·         Marketable securities
• ·         Vacant land
• ·         Interest income from a fixed deposit

Importance of Asset Classification based on usage

Classifying assets based on usage or by using usage based approach is very important to a business. For example, understanding which assets are core to the business and which assets are not in line with the primary activities of the business. Determining which assets are operating assets and which assets are non-operating assets is important to understand 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 so that company will focus more on such assets and maintain them for growth in the long run also.

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