Contents
- What are non current assets?
- Tangible and intangible assets
- Types of non current assets
- Capitalisation of non current assets
- Financing strategies for non current assets
- Current assets vs non current assets
What are non current assets?
According to AASB 101, non current assets are assets that cannot be readily converted into cash within the current fiscal period. Instead, these assets are expected to provide economic value over one or more future fiscal periods.
For instance, imagine a business possessing manufacturing equipment; such equipment will be utilised to create products over an extended period, and the economic benefits will be realised when these products are sold to generate revenue.
Examples of non current assets encompass tangible assets like land, buildings, and vehicles, as well as intangible assets such as intellectual property and goodwill.
Non current assets are often referred to as long term assets, signifying their extended utility and value beyond the immediate financial period.
Non current assets have two main functions:
Investment: These assets can be held with the aim of capital appreciation or for generating rental income.
Production: Non current assets are also employed in the process of producing or delivering goods and services.
Tangible and intangible assets
Non current assets are typically categorised into two main groups:
Tangible assets
Tangible assets are physical, real assets that have a concrete presence. Lenders, such as commercial banks and non bank financial institutions, often prefer these assets as collateral because they can be physically taken, seized, and sold if the need arises for enforcement against the borrower’s collateral.
An example of a tangible, non current asset is a vehicle.
Intangible assets
As per AASB 138, intangible assets are assets that hold economic value within the context of a business but lack a physical form. Intellectual property is a common example of an intangible, non current asset.
These assets are generally less favoured by creditors because there is no tangible object that can be repossessed and liquidated for recovery purposes.
An important point to remember here is that the tangible non current assets undergo depreciation, representing the gradual decrease in their value as time passes. On the other hand, intangible assets are generally subjected to amortisation, which involves spreading out the asset’s cost over its expected useful lifespan.
Types of non current assets
There are various types of non current assets, with the most common categories found on corporate financial statements being:
Property, plant & equipment (PP&E):
According to AASB 116, PP&E includes tangible physical assets like land, buildings, machinery, equipment, and various vehicles, ranging from passenger vans to forklifts and construction vehicles.
Many businesses frequently invest in PP&E, making it a common form of capital expenditure. These assets are capitalised on the balance sheet rather than expensed, and they are often considered valuable collateral security for creditors.
Investments
When an entity has excess cash, its management may opt to allocate this cash into different assets or projects with the expectation of generating future cash flows or capital gains.
Investments can be categorised as either external or internal.
- External investments typically involve equity or debt instruments such as stocks and bonds. They may also encompass derivatives like forward contracts or call options, which could be related to currencies or commodities.
- Internal investments refer to investments in subsidiaries, associate companies, or joint ventures.
Under most accounting frameworks, including both US GAAP and IFRS, investments are generally reported on the entity’s balance sheet at their purchase price, known as book value. Any changes in book value are recorded as gains or losses when the investments are sold or disposed of.
Goodwill
Goodwill is an asset that appears on an entity’s balance sheet when it acquires another business for a price higher than the fair market value of the acquired business’s net assets (which is the total value of assets minus liabilities).
For example, if Entity X buys Entity Y and sees value in aspects like customer lists, brand recognition, intellectual property, or expected cost savings and is willing to pay more than Entity Y’s net asset value at the time of acquisition, then Entity X’s balance sheet will include a non current asset called goodwill, equal to the premium paid.
However, as per AASB 136, goodwill is subject to an annual assessment for impairment. If it is believed that goodwill has lost value since the acquisition, it is adjusted downward to its current fair value. Goodwill impairment is a non cash expense and is often added back to normalised earnings when analysing an entity’s financials.
On the other hand, there are other types of intangible assets, which represent value to an entity but lack physical substance, unlike tangible assets such as property and equipment.
These intangible assets, like trademarks, copyrights, and patents, generate revenue or benefits for the entity over future fiscal periods. They are typically amortised, similar to how tangible assets are depreciated, based on their expected useful life.
Capitalisation of non current assets
Capitalising non current assets is a practise in accounting that aligns with the matching principle, a fundamental concept in accounting standards like US GAAP and IFRS.
The matching principle dictates that business expenses should be recorded in the same accounting period as the economic benefits they generate, regardless of when the actual payments are made. To illustrate this principle, let’s consider an example:
Imagine a business invests $800,000 in a piece of equipment expected to remain useful for five years. Instead of immediately recognising the full $800,000 expense in the year of purchase, the business uses depreciation to spread the cost of the equipment over its expected useful life, even if the payment was made upfront.
The non current asset is initially recorded on the balance sheet at its purchase price, but over time, it is presented at its net value, accounting for depreciation or amortisation, in each subsequent accounting period. This process continues until the asset is fully depreciated or disposed of.
Financing strategies for non current assets
Non current assets are anticipated to provide economic benefits over an extended period, so they are often financed using longer term funding options, including both term debt and equity structures.
Examples:
- Property, Plant & Equipment is commonly funded through methods such as reducing term loans, capital (finance) leases, or commercial mortgages. Lenders typically structure cash repayments to align with the expected useful life of the underlying asset.
- Riskier investments in new business divisions, acquisitions of other companies or technologies may be financed through equity. Equity represents patient capital that is well suited for ventures with higher risks.
Conversely, current assets, which are expected to be converted into cash within a year, are typically funded through shorter term sources like revolving credit, operating lines of credit, and factoring, among others. If an asset is not expected to be converted into cash within a year, it is usually financed using longer term funding mechanisms.
Current assets vs non current assets
Current assets and noncurrent assets are distinct categories within an entity’s balance sheet, each serving different financial purposes and characteristics.
The major differences between the two are as follows:
Nature and duration
Current Assets: These assets are of a short term nature and consist of cash or assets expected to be converted into cash within one year.
Noncurrent Assets: Noncurrent assets are long term in nature and are not expected to be converted into cash within one year.
Purpose and usage
Current Assets: Current assets are primarily used to meet immediate or short term financial needs of a business.
Noncurrent Assets: Noncurrent assets serve the purpose of funding long term or future financial requirements.
Examples:
Examples of current assets include cash, cash equivalents, short term investments, accounts receivables, and inventories.
Noncurrent assets include long term investments, Property, Plant & Equipment (PP&E), goodwill, assets subject to depreciation and amortisation, and long term deferred tax assets.
Valuation
Current Assets: Current assets are typically valued based on market prices or market values.
Noncurrent Assets: Noncurrent assets are valued at their original cost less depreciation.
Tax implications
Current Assets: Selling current assets typically results in profit from regular trading activities and may have tax implications.
Noncurrent Assets: Selling noncurrent assets leads to capital gains, and the seller may be subject to capital gains tax.
Revaluation
Current Assets: Revaluation of current assets is generally not common, although exceptions may exist, such as revaluing inventories in specific cases.
Noncurrent Assets: Noncurrent assets, especially PP&E, may undergo revaluation. For example, when the market value of a tangible asset falls compared to its book value, an entity may need to revalue that asset.
Businesses are obligated to provide comprehensive information regarding their non current assets in their financial statements. This disclosure includes specifying the nature of these assets, their recorded values, any accumulated depreciation or amortisation, as well as any impairment losses incurred.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.