Professor Adams' Lecture Materials

LO3-02: Identify and describe the various asset classifications.

Operating cycle

An important term for assets classification is operating cycle, which is defined as a period of time necessary to convert cash to raw materials, raw materials to finished product, the finished product to receivables, and then finally receivables back to cash. In general, for simplification, we assume each operating cycle to last for one year.

Current assets

Currents assets include cash and all other assets expected to become cash or to be used within one operating cycle.

Typical current asset accounts

- Cash and cash equivalents: Cash and investments that will mature in 3 months or less.
- Short-term investments: Investments that will mature in more than 3 months, but in less than a year.
- Accounts receivable: Money owed to company by its customers.
- Inventory: Materials, partially finished product (called work-in-process), and finished product that will be sold to customers.
- Prepaid expenses: Expenses that the company has paid in advance of receiving a product or service (e.g., company pays rent at beginning of month).

Long-term assets

All assets not expected to become cash or to be used one operating cycles.

Typical long-term asset accounts

- Investments: Assets not directly used in operations (e.g., ownership in another firm).
- Property, plant, and equipment (PP&E): Tangible (i.e., you can touch and feel it) long-lived (much longer than a year) and used in the operations of the business (e.g., a machine used on the assembly line).
- Intangible assets: An asset that has no physical substance, but has value to the firm. [01]
  - A patent on a product the firm developed.
  - A list of customers.
  - Trademarks.
  - Copyrights.
- Other long-term assets: This is a default category for any long-term asset that does not fall in any of the above long-term asset categories. As an example, Nike reports promotional expenditures related to long-term endorsement contracts in this category.

Footnotes

[01] Intangible assets cannot be recorded in a company's financial statements unless they have been acquired from another company. This typically happens through Merger and Acquisition (M&A) transactions, which you will see in Advanced Accounting. Some, like Baruch Lev from New York University (NYU), argue that this leads to a decrease in the relevance of accounting as a profession. In his book, The Death of Accounting and the Path Forward for Investors and Managers (Gu and Lev, 2016, John Wiley and Sons, Hoboken, NJ), Professor Lev makes the following argument.

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