Overview
The International Financial Reporting Standards (IFRS) are governed and issued by the International Accounting Standard Board (IASB).
Assets and liabilities are key components of a balance sheet for any company. However, these assets and liabilities must be recognized and reported according to the IFRS rules.
Further, assets can be classified into different categories. Each category can then be defined as per the existing IFRS rules.
Defining assets and their classification can substantially impact a company’s balance sheet. Hence, care must be taken when defining an asset and reporting it under the IFRS rules.
Asset –Definition
We can define an asset as any source that offers potential economic benefit. An individual or a company can own the source.
For companies, we can define an asset as a source that can add value by generating cash flow. Assets can also reduce expenses or generate goodwill. Thus, generating economic value in any form defines an asset.
IFRS Definition of an Asset
A company can recognize a source as an asset in its financial statements if it meets the definition of IASB. The IASB defines an asset as:
“A present economic resource controlled by the entity as a result of past events.”
This is a revised IASB definition of an asset.
The previous definition of an asset stated:
“A resource controlled by the entity due to past events and from which future economic benefits are expected to flow to the entity.”
In the current definition of an asset, the economic resource is defined by the IASB as:
“A right that has the potential to produce economic benefits.”
The IASB has changed the way assets were defined earlier. Previously, any source that had an expected economic benefit in the future could be recognized as an asset.
Currently, any source that has the potential is recognized as an asset.
Under the current definition laid by the IASB, the source must only have the potential to produce an economic benefit. The company doesn’t have to wait until the economic benefit is realized.
The economic benefit can also be recognized in several ways. For example, a patent adds to the worth of a company. Hence, it should be recognized as an intangible asset for the company.
Similarly, if a company owns a source (such as a property) and doesn’t utilize it currently, it can generate economic benefits. Thus, it should also be immediately recognized as an asset.
Important – Control of An Asset
Note that the current definition of an asset defines a source “controlled” by the company. Generally, a controlled source refers to the ownership of the source. However, it may not be the case for many assets.
A long-term financial lease of a source would result in significant control over a source for its useful life.
For example, a company leasing important manufacturing equipment for its useful life will have control over it. Even if the company does not own the source, it should be recognized as an asset.
In the same context, some assets would not qualify as an asset. For instance, a company having a skilled labor force is a potential source that generates the most valuable economic benefits.
But as the company does not have “control” over its workforce, it cannot recognize it as an asset.
Note: Goodwill arising due to human capital, patent, or any significant achievement is recognized and reported as an intangible asset in the balance sheet.
Changes to the IASB Framework
As we can see, the IASB changed the definition of an asset. Most importantly, the change addresses the expected economic benefits with the potential economic benefit.
Companies do not need to meet any threshold criteria before recognizing a source as an asset. Also, it doesn’t need to generate any economic benefits. The source can be recognized as an asset even if the company doesn’t utilize it.
Another key point remains regarding the control over the source. The company doesn’t need to own a source legally to recognize it as an asset. Long-term financial and operating leases are important examples of such cases.
Types of Assets Defined under IASB Framework
Once a company recognizes a source as an asset, it can be further classified into different categories.
A company can divide its assets into current and long-term assets or tangible and intangible assets.
An asset that fulfills the recognition criteria of an asset generally meets the definition of a tangible asset. It is the classification of current or long-term and intangible assets that is important.
Current Assets
A company can classify assets in terms of current and non-current assets. The IAS 1 defines the basic structure and elements of the financial statement.
The IAS 1.65 states the definition of a current asset as:
- Expected to be realized in the entity’s normal operating cycle
- Held primarily for trading
- Expected to be realized within 12 months after the reporting period
- Cash and cash equivalents (unless restricted).
An asset initially defined as a current asset that exceeds in economic life above 12 months should be mentioned in accompanying financial statement notes.
Fixed or Non-Current Assets
IAS 1 defines the current assets. All other assets should be classified as non-current or fixed assets owned by a company (IAS 1.66).
An important part of fixed asset classification is recognizing an entity’s property, plant, and equipment (PPE). IAS 16 deals with the recognition and definition of PPE owned by an entity.
The IAS 16 defines property, plant, and equipment as assets if:
- The future economic benefits associated with the asset will probably flow to the entity, and
- The cost of the asset can be measured reliably.
All items of PPE are recorded at their initial costs. Depreciation rules apply separately as defined through the IFRS.
Intangible Assets
An intangible asset is a source without physical substance. The source first has to meet the definition of an asset as defined above. IAS 38 defines the intangible asset and the criteria to record it in the financial statement.
- An identifiable non-monetary source without physical substance.
- The company controls the resource as a result of past events.
- The source offers potential future economic benefits.
An intangible asset can be purchased or self-created (or developed) by a company. The IAS 38 requires a company to record an intangible asset if it meets the following two conditions:
- The future economic benefits that are attributable to the asset will probably flow to the entity; and
- The cost of the asset can be measured reliably.
Assets Held for Sale or Discontinued
Assets held for sale or discontinued operations form an important part of asset classification as well. Large companies hold such assets and subsidiaries that are marketed for sale.
The IFRS 5 defines the assets held for sale if they meet the following criteria:
- Management is committed to a plan to sell
- The asset is available for immediate sale
- an active program to locate a buyer is initiated
- The sale is highly probable within 12 months of classification as held for sale (subject to limited exceptions)
- The asset is being actively marketed for sale at a sales price reasonable about its fair value
- Actions required to complete the plan indicate that it is unlikely that the plan will be significantly changed or withdrawn.
Such assets must be disposed of through sale. A large company may sell subsidiaries and should also recognize them as assets held for sale.
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