Classifying assets and separating money into ownership categories is one of the most complicated parts of managing a large business. For example, taking stock cards could be considered cash or working capital.”
The company’s management has to decide how they will classify financial assets. For example, they might think the stock is a financial asset but not classified as an investment asset. However, it would still need to be included as an asset to track its liabilities and equity over time. Many companies think they are good at classifying their financial support but hesitate to do so. They may classify financial assets using a generalized approach, vague description, or not state it.
What are Financial Assets?
Financial assets arise from contractual agreements such as stocks, bonds, or loans. Other examples are government securities, real estate, receivables, and accounts receivable. They are initially recorded at fair value and may be adjusted for other than temporary changes in value. The following financial assets should be reported on the balance sheet:
Cash can be considered a financial asset for some businesses. It’s listed with current assets and classified as cash, cash equivalents, or short-term investments on the balance sheet. It’s important to remember that money is always available because of its liquidity. Trade receivables are classified as financial assets on the balance sheet. They are recorded at their net realizable value, the estimated selling price of the goods, less an allowance for returns and discounts. Trade payables are also classified as financial assets on the balance sheet. However, they are listed with liabilities and represent amounts due to be paid in the future.
Here we’ll discuss the simple classification of financial assets.
1. Held To Maturity (HTM)
Assets that are expected to be held until maturity. In simple terms, the HTM asset is scheduled to be held for a long-term period. If the financial asset is classified as an HTM, it should not be included as a current asset (an asset that will be realized in 12 months or less).
This is the easiest and most common method of classifying assets. The assets are classified in “The orders as held to maturity .”The asset is paid for, but nobody owns it until maturity. This method does not require further analysis or estimation skills and is a very quick and easy way to analyze cash flow.
2. Loans And Receivables (LAR)
An asset that will be paid back with interest within 12 months is a current asset. If the interest rate on a loan is higher, it can be classified as a current asset. Sometimes, the company doesn’t have to pay back until 18 months or even longer. The period of an asset has to be recorded so that you can divide all of your financial assets into three categories:
LTA represents the current assets that have been classified as long-term assets. At this point, the company’s financial position is long-term, but it could change quickly depending on market conditions or other external factors.
3. Fair Value Through Profit or Loss (FVTPL)
The fair value of an asset through profit or loss (FVTPL) method is a “Fair Value” estimate of the assets that are held for trading purposes. It’s an amount at which it could be sold, the price at which it could be traded. At this point, it doesn’t matter what the actual selling price is. The fluctuations in value will be recorded in current income and retained earnings – directly or indirectly – if you follow this method correctly.
When there is a public market, this method can be used to classify assets. The active market traded at the asset’s value will affect the earnings in the current period. If this method of determining financial assets has been recorded, it will show “FVTPL” on the income statement and balance sheet.
4. Available For Sale (AFS)
The available-for-sale (AFS) method is similar to the FVTPL method, with one major exception. The FVTPL asset is measured at fair value through profit or loss. However, the AFS asset is an available-for-sale asset that is not measured at fair value; it’s recorded directly in equity, and the unrealized gain will be shown in the “gains on investments” section of the income statement.
If the financial asset is available for sale, it will be classified as an available-for-sale asset. The most critical factors in deciding whether it’s a current or non current asset are whether the company plans to hold the asset until maturity or sell it. In this case, the sales price needs to be estimated because of the lack of a public market. If external factors affect the company’s ability to sell by fair value, an allowance will be made for those factors.
The classification of financial assets depends on the company’s view of them and how they are used. The company’s accounting policy should consider each financial asset’s specific characteristics. A company with a relatively simple financial statement can use the FVTPL method. However, if it is more advanced, they should use one of the other methods.