Current Assets: Meaning and Classification

In this article we will discuss about the meaning and classification of current assets.

Meaning of Current Assets:

Current assets are defined as “cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business”. Items are included in current assets on the basis of whether they are expected to be realised within one year or within the normal operating cycle of the enterprise, whichever is the longer.

However, the classification of items as current or non-current in practice is largely based on convention rather than on any one concept. The above definition, however, does not place the main emphasis on nature of the operation of-a going concern.

The emphasis should be on the frequency of the opportunity to decide whether or not to recommit the funds for use in current operations. Current assets in aggregate may be just as permanent as the investments in non- current assets, but the opportunity for reinvestment in current operations occurs within the current operating cycle of business.

However, once assets are committed by management for investment in specific long-term forms, they should not be classified as current assets. For example, cash, securities or other assets committed by management for the later acquisition of plant and equipment or for other non-current uses should not be included among the current assets. The commitment need not be legally binding on management, but it should be explicit.

The operating cycle is defined as the time it takes to convert cash into the product of the enterprise and then to convert the product back into cash again. This concept permits an operational demarcation between short-term commitments and long-term commitments. Plant and equipment items are omitted from the current assets classification because their turnover periods cover many product turnover periods.

One of the difficulties in the way the operating cycle concept is applied in practice is that if it is less than one year, the one year rule still applies; the result is that the current assets classification does not disclose consistently the frequency of the circulations of assets.

But even if the operating cycle criterion were applied consistently, there would still be some major difficulties because of the complexity of many business enterprises and the resultant inability to determine the length of the operating cycle.

Because of these difficulties regarding the interpretation of the operating cycle and because of the lack of evidence regarding the relevance of the current assets classification to any specific user’s needs, other methods of classifying assets should be investigated.

Classification of Current Assets:

Current assets are set off from non-current assets because of their importance in a company’s current position. Current position is another concept, subsidiary to the overall notion of financial condition, which has to do with a company’s liability to meet its immediate maturing obligations in the ordinary course of business with the assets at hand.

Within the classification of current assets, one typically finds the following:

1. Cash:

Cash balances available for withdrawal are normally shown in a single account with the title cash. Separate disclosure should be made of cash that is restricted as to withdrawal. Cash and the various forms of money are expressed in terms of their current value, which is definite.

Therefore, any gains or losses resulting from the exchange of other assets for the given amount of cash or money forms should have been recognised; no gain or loss should be recognised from the holding of cash and money forms except possibly in consideration of purchasing power gains and losses during periods of price-level changes. Holdings of convertible foreign currency or money should be expressed in terms of the domestic equivalent at the balance sheet date.

2. Receivable:

Receivables encompass monetary claims against debtors of the firm.

They should be reported by source—those arising from:

(a) Customers

(b) Parent and subsidiary companies

(c) Other affiliated companies

(d) Certain related parties such as directors, officers, employees, and major shareholders.

The term accounts receivable is commonly used to refer to receivables from trade customers that are not supported by written notes. Receivables are typically presented at face values, with the required reduction for uncollectible accounts and unearned interest reported in adjacent contra accounts.

3. Marketable Securities:

Marketable securities represent temporary investments made to secure a return on funds that might otherwise be unproductive. Whether an investment is classified as temporary or not depends largely on management intent. To be considered a temporary investment, a security must not only be marketable, but management must plan to dispose of it if it needs to raise cash.

Under conventional accounting procedures, securities (when held for current working capital purposes) are generally recorded on the basis on the lower of cost or market. The argument for this method has been that cost is generally the most relevant basis for measuring the gains or losses realised when the securities are sold.

If market price rises above cost, the increase in value is not generally recorded because it is thought that this gain is unrealized in the technical sense of the word and because it possibly may disappear before the assets is sold.

If the market value of the securities is less than cost, however, it is thought that the losses should be recorded and the securities should not be shown in the balance sheet in excess of their current realisable value.

4. Inventories:

Inventories include those items of tangible property that:

(a) Are held for sale in the ordinary course of business,

(b) Are in process of production for such sale, or

(c) Are to be currently consumed in the production of goods or services to be available.

The cost of inventory includes all expenditures that were incurred directly or indirectly to bring an item to its existing condition and location. Inventory is recorded at cost except when the utility of the goods is no longer as great as it cost. Several cost flow assumptions may be used to allocate costs between cost of goods sold and ending inventory.

The most widely used are:

(a) FIFO,

(b) LIFO, and

(c) Average cost.

5. Prepaid Expenses:

Prepaid expenses include prepaid rent, insurance and interest. They are not current assets in the sense that they will be converted into cash; rather they are item that if not prepaid would have required the use of cash.

They are sometimes referred to as deferred charges, because the charge to income resulting from the prepayment is delayed until it can be properly matched with appropriate revenues. Other current assets represent those accounts that could not be included in other captions and may include deferred income taxes, advances, or deposits held by a supplier, and property held for resale.