Current and noncurrent classification

A classified balance sheet separates current and noncurrent assets and liabilities. The distinction concerns how the company expects to use resources and settle obligations. An account name alone may not supply enough information.

Current and noncurrent assets

Current assets generally include cash available for operations and resources expected to be sold, collected, or consumed within a year or the normal operating cycle, whichever is longer. Noncurrent assets include resources retained for continuing use, such as equipment used through several years of operations.

The operating cycle describes the company's ordinary process of acquiring or producing goods or services, selling them to customers, and ultimately collecting cash. It helps determine the period used to classify certain assets and liabilities as current or noncurrent.

For a company that sells goods, the operating cycle begins when the company acquires or produces inventory and ends when it collects cash from customers. If the company sells on credit, the sale creates a receivable, and the cycle continues until the customer pays.

For a service company, the corresponding process begins when the company uses labor, supplies, and other resources to provide a service. It ends when the company collects cash from the customer. If the company bills after providing the service, the receivable remains part of the process until collection.

Issuing shares and borrowing money are financing activities, not steps in the operating cycle. The company may spend that cash on operations, but obtaining financing does not make the cash part of the sale-and-collection process.

Operating equipment also generally remains outside the cycle. Workshop machines and delivery vehicles support the sale-and-collection process, but they do not pass through it as inventory or receivables. Their classification does not depend on the length of the operating cycle.

The operating cycle differs from the accounting cycle, which concerns recording, adjusting, and closing accounts. It also differs from the reporting period. A year-end reporting date does not require all customer balances to be collected by that date.

For current classification, use 12 months or the company's normal operating cycle, whichever is longer. A company with several operating cycles within 12 months, or with no clearly defined operating cycle, uses a 12-month period. ASC 210-10-45-3 establishes this time rule.

Intended use still matters. Machines held for ordinary sale are inventory. Machines the company uses to provide services over several years are noncurrent property and equipment. Cash restricted to buying a long-lived asset is also noncurrent, even though it is already cash. Prepaid insurance used during the coming year is current because the company will consume the coverage.

Current and noncurrent liabilities

Current liabilities generally include ordinary operating obligations, such as amounts owed to suppliers and employees, and amounts due within the coming year. An advance from a customer can also be current when the company owes goods or services during its normal operating cycle. Settlement does not always require a cash payment.

A loan may have both current and noncurrent portions. For an ordinary loan without conditions that change classification, principal due within the coming year is current. Principal due later is noncurrent. The original length of the loan does not make all remaining payments noncurrent.

Specific borrowing conditions can change that result. Check the stated terms rather than assume every loan follows this simple schedule. ASC 210-10-45-8 through 45-9 addresses ordinary current obligations; later instruction covers debt exceptions.

Classification and payment capacity

Liquidity concerns a company's ability to meet near-term obligations as they come due using resources expected to become available in the near term. Current classification does not mean that every current asset is cash available for payment. A receivable must be collected. Inventory must be sold and, if the sale is on credit, the resulting receivable must be collected. A prepayment provides a service benefit rather than cash.

Even correctly classified totals leave timing questions unanswered. A company may owe a supplier before it expects customers to pay. Assessing its ability to make that payment requires the relevant collection and payment dates.

Classification check

A cleaning company has an operating cycle shorter than a year. It holds supplies for next month's work and floor machines it will use for several years. It owes employees for work already completed and has a loan with payments due both next year and in later years. No borrowing condition changes the schedule. Classify each resource and obligation, and explain the reason.

Compare your reasoning

Employees will consume the supplies in current operations, so the supplies are current assets. The floor machines are noncurrent because the company retains them for repeated use. Wages payable are current because the company owes payment for completed work. Principal due next year is current; principal due later is noncurrent.

The supplies and floor machines both help employees provide services, but their uses differ. The loan's original term does not remove the upcoming payment requirement.

Sources

The Financial Accounting Standards Board's Accounting Standards Codification (ASC) provides the relevant US accounting requirements. ASC 210-10-45-1 through 45-4 covers current assets, prepayments, the operating-cycle period, and excluded resources. ASC 210-10-45-8 through 45-9 covers ordinary current obligations.