What is Operating Cycle?[5 Marks]

Operating Cycle
An operating cycle is the time between the acquisition of assets for processing and their realisation in cash or cash equivalents. Where the normal operating cycle cannot be identified, it is assumed to have a duration of 12 months.
Where a company constructs office buildings for third parties and the construction takes two to three years to complete, the company's construction work in progress would be classified as a current asset because construction over two to three years is the company's normal operating cycle.
The same normal operating cycle applies to the classification of both assets and liabilities.
If a company has different operating cycles for different parts of the business (e.g. retail and construction), then the classification of an asset as current is based on the normal operating cycle that is relevant to that particular asset. The company need not identify a single operating cycle.
If a liability is part of the working capital used in the entity's normal operating cycle, then it is classified as current even if it is due to be settled more than 12 months after the reporting date.
For example, an entity develops software for third parties that takes two years to complete and receives payment for this service upfront. Deferred revenue recognised as a result of the upfront payment is classified as current even if the related service is not expected to be performed within 12 months of the reporting date.