A company cannot function without its assets. They are the resources that are needed to run and progress a business. A company has current assets and non-current assets. Current assets are generally short-term assets as they can be easily converted into cash within a year, for example, raw materials, cash & cash equivalents, account receivables, etc. While non-current assets are long-term assets that cannot be converted into cash within a year. For example, intangible assets like goodwill and fixed assets like plants, machinery, building, land, etc., all benefit a company for several years.
When we talk about the day-to-day workings of a company, we generally think about current assets as they are the company’s highly liquid assets. They fund daily business operations as well as pay operating expenses like bills and loans.
However, a company also invests in long-term assets called non-current assets, which tell about the company’s investing activities. Unlike current assets, they provide benefits to a company for more than a year. Non-current assets support the core operations of a business. They are further classified into two types, tangible and intangible assets. Let’s discuss non-current assets in detail.
A non-current asset is a long-term asset. A company can either invest in a non-current asset or can acquire it through mergers or acquisitions. A non-current asset is a low-liquid asset that cannot be converted into cash within a year. They appear on the balance sheet under the heading Property, Plant, and Equipment (PP&E), which helps investors understand the company’s capability to use resources and generate revenues. These assets can either be depleted, amortised, or depreciated. There are three types of non-current assets which are tangible, intangible, and natural resources. Let’s examine each in more detail.
Tangible Assets or Fixed Assets have a physical form and a recorded monetary value. A company owns them for its core operations. You can derive the actual value of a tangible asset by subtracting the accumulated depreciation from the original acquisition cost of the asset. However, not all tangible assets depreciate. Some, for example, land appreciates in value over time.
It also helps in computing the company’s net worth. We can determine this by calculating the non-current asset to net worth ratio of a company. Net worth represents the true value of a company by subtracting liabilities from total assets. This ratio compares long-term assets with the part of assets that a company owns. A high non-current asset to net worth ratio simply means that a company has more non-current assets. Whereas if a company has a low ratio, it means that a company’s assets are in the form of debt, which means more financial trouble in its operations.
An intangible asset is an asset that lacks a physical form but has an economic value. They are either definite or indefinite.
A company can either create an intangible asset or acquire one through purchases, for example, mergers & acquisitions.
Intangible assets are listed on the balance sheet as per the cost or revaluation model. However, goodwill is not amortised but checked for impairment annually. When the carrying value of an intangible non-current asset exceeds the fair value, then an impairment loss needs to be recognised.
A company derives natural resources from the earth. They occur naturally and are readily available. They are also called exhaustible or wasting assets because they are used when they are extracted. For example, Natural Gas has to be pumped out of the earth to be used.
Natural assets list on the balance sheet at the cost of acquisition plus development and exploration costs and less accumulated depletion.
Long-term investments include assets such as equity which includes stocks, mutual funds, and bonds. When investors buy such securities in the financial market, they hope that these assets will appreciate and give a good return. These assets are also listed on the company’s balance sheet.
When a company acquires another company, it buys assets and intangibles like a client base, quality of employees, brand name, or reputation. Therefore, it implies that the company pays the fair market value of the intangible assets. Goodwill is generally paid in excess of the acquired company’s net value (Assets – Liabilities). The difference between the total MV (market value) of liabilities and assets and the purchase price of an acquired company is the value of Goodwill. If the company is unable to assign this excess purchase price to any other intangible non-current asset, then it is set to Goodwill.
There are two different methods to report non-current assets on the balance sheet, one is Cost Model, and the other is Revaluation Model. To know more, please go through the ensuing paragraphs.
Under the cost model, the asset is recorded at the net book value, i.e., cost minus accumulated depreciation. Depreciation is the amount to record the reduction in the asset’s useful economic life. The depreciation charges are recorded in a separate account called the accumulated depreciation account. They help identify the net book value of a non-current asset at any time.
The cost model’s main advantage is that there will be no biases (unlike in the revaluation model) in valuation as a non-current asset cost is readily available. However, this does not provide a correct worth of a non-current asset since the prices of assets change with time. This is precisely right for non-current assets such as property, where prices constantly increase.
This model is known as the fair value method of asset valuation or mark-to-market approach. According to this method, a non-current asset is recorded at a revalued amount minus depreciation. To implement this method, the company needs to measure fair value reliably. If the company cannot derive a reliable, fair value, the asset should be valued using the cost model.
An increase arising as a result of a revaluation should be credited to the separate reserve named ‘revaluation surplus’ and recognised as an income. If revaluation results in a drop in value, it should be recognised as an expense. Revaluation surplus should be directly transferred to retained earnings. Non-current assets under both models undergo depreciation to allow for the reduction in the useful life.
The prime reason companies adopt a revaluation approach is that it provides a more accurate picture than the cost model. It ensures that non-current assets are shown at market value in financial statements. But this is an expensive exercise since revaluation must be carried out at regular intervals. Moreover, the management may sometimes get biased and assign an increased revalued amount to assets than the reasonable market value, thus leading to overestimation.
Cost Model Revaluation model | |
Assets are valued at the cost paid to acquire them. | Assets are shown at fair value. |
Class of Assets | |
Class is not affected. | The entire class has to be revalued. |
Valuation Frequency | |
Valuation is only carried out once. | Valuations are carried out at regular intervals. |
Cost | |
It is a less costly method. | It is costly compared to Cost Model. |
This ratio determines how a company utilises its non-current assets and how optimally they are used to generate revenues. A low non-current turnover ratio implies that a company is not utilising its non-current assets optimally. And a high non-current asset turnover ratio suggests that a company is optimally using these assets.
Non-current Asset Turnover = Net Sales Revenue/Net Book Value of Non-Current Assets.
For example, if the company’s revenue for the period is £60 billion and non-current assets are £20 billion.
Then,
Non-current asset turnover = £60 bn / £20 bn = 3.
This ratio helps in the decision-making process by management; for example, if the management wishes to acquire a fixed asset, then it needs to calculate the fair cost price of the asset so that the ratio improves.
This ratio measures the company’s investments in low liquid non-current assets. Non-current asset to net worth ratio is useful to evaluate shareholders’ equity amount that is used to finance a business operation. A high ratio suggests that the majority of a company’s long-term investments are in the form of debt. However, you need to analyse the balance sheet to see which non-current assets impact the calculation the most.
Non-current asset to Net worth = Non-current Assets/Net Worth.
For example, Let’s assume XYZ company’s balance sheet has total non-current assets (PP&E, intangible assets, advances, investments) worth $9,090 million and the shareholder’s equity or net worth valued at $ 2,770 million. Let’s apply this formula and find the ratio.
NCA/NW = 9090/2770 = 3.281
We can see that the non-current assets of XYZ company are at least three times more than its shareholders’ equity. Therefore, we can see that the majority of the company’s assets are liabilities. Generally, this would be concerning, but you also need to look at the competitors’ results from the same industry as well.
It is easy to get confused between a non-current asset and non-current liability. A non-current liability is a long-term liability that appears under liabilities and shareholders’ equity on a balance sheet.
A non-current liability is a company’s financial obligation that is not expected to be paid within an accounting year. The financial ratios analyse non-current liabilities to determine the company’s debt-to-asset ratio, debt-to-capital ratio, leverage, etc. Analysts and creditors keep a watchful eye on the company’s non-current liabilities as it determines the level of leverage and stability of cash flows.
A stable cash flow means a company can bear a higher debt load without the risk of default. The inadequate non-current liabilities will make investors hesitant to invest in the company and keep creditors away from doing business with a company.
This article will be lacking if we do not discuss current assets. Because both current and non-current assets are recorded in a company’s balance sheet, and together they show a company’s total assets.
Current Assets or current accounts are short-term assets that are expected to be consumed, exhausted, used, or sold within an accounting year. They are used for the company’s immediate needs, funding day-to-day expenses and operations. Current assets include accounts receivable, marketable securities, cash & cash equivalents, prepaid liabilities, stock inventories, and other liquid assets.
Current assets are highly liquid assets meaning they can be converted into cash within an accounting year. However, it relies on the nature of the business and the type of products it markets, for example, raw materials, inventory, crude oil, foreign currency, or fabricated goods. Generally, inventory comes under current assets, but it is tough to sell machinery or land, so it is excluded from current assets. But finished goods and raw materials are sold quickly; therefore, it falls under inventory.
Inventory is a current asset because the company plans to sell the products within a year. It includes raw materials (supplies that produce finished goods), work-in-progress (WIP), and finished goods (ready for sale). It appears as a buffer between manufacturing and sale. If an item in an inventory is sold, its cost is transferred to the Cost of Goods Sold (COGS). There are three methods to calculate inventory; First-in, first-out (FIFO), Last-in, first-out (LIFO), and weighted average method. If a business sells inventory faster than its competitors, it incurs low opportunity and holding costs. This helps to sell the goods efficiently.
For example, due to the fast sales turnover of the brand “Lifestyle,” another fashion retailer, “Max,” is constantly under pressure to quickly sell its inventory too. The production material and fabric to produce this apparel is considered raw material.
Account receivable is the company’s money for products or services used or delivered but is still unpaid by the consumers. As long as the consumers can pay within one year, they are considered current assets. A part of it might not make it under account receivable if they are long-term credits.
It is also likely that some accounts may never pay in full. They would be considered under “allowance for doubtful accounts” and subtracted from account receivable. There is also a chance that an account might never be collected. Then it is considered a “bad debt expense” and is, therefore, not regarded as current assets.
Prepaid expenses are advanced payments made by a firm for goods or services to be received in the future. These are current assets, but they cannot be converted into cash. However, they free up the capital for other uses like payments to contractors or insurance companies.
The highly liquid items are generally ranked higher and follow an order on the balance sheet.
Apart from funding the business’s daily operations and paying daily expenses like loans and bills, current assets reflect the cash and liquidity position of a company. The investors and creditors keep a watchful eye on the company’s current assets to assess the risk in operations and the company’s value.
Basis | Current Assets | Non-Current Assets |
Meaning | Cash & Cash equivalents; are easily converted into cash within an accounting year. | Low-Liquid assets; are not easily converted into cash and benefits for more than a year. |
Components | Cash & Cash equivalents, inventories, short-term investments, account receivable and prepaid expenses. | PP&E, long-term investments, accumulated depreciation, Goodwill, amortisation, long-term deferred tax |
Nature/Investment | Short-term investment or resource of a company | Long-term investment or resource of a company |
Types | It doesn’t have a type | Divided into two categories, tangible and intangible assets |
Valuation | Appear on the balance sheet at market prices. | For tangible assets, they appear on the balance sheet at acquisition cost less accumulated depreciation. For intangible assets, they appear at cost less depreciation. |
Revaluation | Not subjected to revaluation except for inventories in some cases. | Revaluation is necessary; a comparison needs to be made between market value and the book value of an asset. |
Tax Implication | Sales of current assets result in trading profits. | The sale of non-current assets results in capital gains; capital gain tax is applicable. |
Assets are essential to run a company and scale its business. Managing an asset is very important as it monitors, tracks, and manages assets to deliver optimal results from their disposal. Managing current and non-current assets enables a company to identify and handle the associated risks to protect their value better. The correct records of both the assets help improve the accuracy of the financial statements.
Non-current assets support a company’s core operations. They are long-term investments that accrue benefits for several years. Both tangible and intangible assets help in computing a company’s net worth.
A non-current asset can also be called a fixed asset. However, a fixed asset is only a type of non-current asset. Non-current assets are categorised into two types, tangible and intangible assets. A tangible asset has a physical form and a monetary value, for example, land, machinery, equipment, plant, building, or property. A non-tangible asset lacks a form but has an economic value like intellectual property, goodwill, trademark, copyright, or brand. All tangible assets are fixed assets.
A company owns non-current assets; hence, it is a company's resource. Whereas non-current liabilities are also a company's resource, however, they are borrowed and, therefore, must be returned. They are a company's financial obligation and are not expected to be paid within an accounting year. So, non-current assets are not liabilities of a company if they are owned, not borrowed.
Fixed non-current assets are subjected to depreciation as their value gradually decreases. For example, machinery and equipment depreciate. The cost of the acquisition of an asset less accumulated depreciation results in the actual value of a tangible asset. However, not all non-current assets depreciate. Some deplete, for example, natural resources such as gas, coal, etc., while others appreciate or amortise such as land and goodwill, respectively.
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