Accounting And Finance For Managers - Accounting For And Presentation Of Current Assets
Accounting for and Presentation of Current Assets
Current assets are cash and other assets that will be converted to cash or used up during a relatively short period of time, usually a year or less. Current assets are normally listed in the order of liquidity (how readily they can be converted to cash).
Every entity has an operating cycle in which products and services are purchased, services are performed on account, payment is made to employees and suppliers, and finally cash is received from customers.
Accounts that Comprise Current Assets are:
- Marketable (short-term) securities
- Accounts Receivable
- Notes Receivable
- Prepaid Expenses
Cash and Marketable Securities
The cash amount on the Balance Sheet is the amount of cash owned by the entity on the Balance Sheet date.
Short-term marketable securities held until maturity is shown on the Balance Sheet at cost, which is usually about the same as market value.
Securities expected to be held for several months after the Balance Sheet date are shown at market value.
Interest income from marketable securities that has not been received must be accrued.
Account receivables are amounts owed to an entity by customers (debtors). An account receivable arises when a service or product is sold and cash is not received immediately.
Accounts receivables are reported on the Balance Sheet at their “Net Realizable Value.” This amount is the amount of cash expected to be collected from the accounts receivable.
When sales are made on account, a very high probability exists that some accounts receivable will not be collected.
The matching of revenues and expenses concept requires that the cost of uncollectible accounts receivable be reported in the same period as the revenue that was recognized when the account receivable was created.
The amount of accounts receivable not expected to be collected is recorded and reported in the account “Allowance for Bad Debts” which is a “contra asset” account on the Balance Sheet.
A note is an unconditional written promise to pay a definite sum of money at a certain date, usually with interest at a specified rate.
A note receivable is on the Balance Sheet of the entity to which the note is given.
A note receivable arises when:
A sale is made and a note is taken from the customer.
A customer gives a note for an amount due on open account
Money is loaned and a note is received as evidence.
The inventories asset account contains the cost of items that are being held for sale.
When an item of inventory is sold, its cost is transferred from the inventory asset account, a Balance Sheet account, to the cost of goods sold account, an Income Statement account.
When the inventory includes the cost of several units of the same item sold, determining the cost of the items sold is handled in different ways.
Alternative Inventory Cost Flow Assumptions
Specific Identification – an alternative cost flow assumption that links cost and physical flow.
When an item is sold, the cost is determined from the entity’s records. The cost of the item is then transferred from the Inventory account to Cost of Goods Sold.
The amount of inventory at the end of the year is the cost of the items held in inventory.
Weighted Average – an alternative cost flow assumption applied to individual items of inventory.
The weighted average alternative involves calculating the average cost of the items at the beginning inventory plus purchases made during the year.
Once the average cost is calculated, it is used to determine the Cost of Goods Sold and the carrying value of ending inventory.
First-in, First-out (FIFO) – an alternative cost flow assumption that transfers out beginning inventory cost s a monetary amount computes unit cost based only on current-period cost and output.
If item costs do not change from period to period, the FIFO method yields the same results as the weighted average method
Under the FIFO method, the equivalent units and manufacturing costs in the beginning work in process are excluded from the current-period unit cost calculation as. This method recognizes that work and costs carried over from the prior period legitimately belong to that period.
FIFO assumes that units in beginning work in process are completed first, before any new units are started. Thus, one category of completed units is that of beginning work-in-process units. The other category is for those units started and completed during the current period.
The FIFO method produces a more accurate unit cost than the weighted average method if changes occur in the prices of manufacturing inputs from one period to the next.
Last-in, First-out (LIFO) – an alternative cost flow assumption opposite to FIFO. Remember that FIFO and LIFO refer to cost flow, not physical flow.
Under LIFO, the most recent costs incurred for merchandise purchased or manufactured are transferred to the income statement as Cost of Goods Sold when items are sold
The inventory on hand at the Balance Sheet date is costed at the oldest costs, including those used to value the beginning inventory.
When costs are declining over time, LIFO results in higher profits than FIFO.
A prepaid expense is an asset awaiting assignment to expense. Some expenditures made in one period are not properly recognizable as expenses until a subsequent period. Prepaid expenses result from the application of accrual accounting.
For prepaid expenses, expense recognition is deferred until the period in which the expense applies. Prepaid expenses include insurance premiums and rent.