To recap the previous post covering the basics of the balance sheet, Current assets are all those assets which are expected to be converted into cash or used up within one year or one operating cycle, whichever is greater. Current liabilities on the other hand are all those obligations which are expected to be settled within one year or one operating cycle whichever is greater. Together they tell us about the operating activities of the firm.
Today we will see the different types of current assets and current liabilities that appear on a balance sheet. So let’s begin.
Current assets examples
Cash and Cash equivalents
Cash is the most liquid current asset. Cash equivalents are considered to be as good as cash, as they are highly liquid short term securities that can be readily converted into cash. For example, treasury bills, commercial paper and money market mutual funds. These securities have deep and liquid short term markets. Cash equivalents are considered current assets as they are expected to be converted into cash in the near term and expensed.
Marketable securities are those securities that are publicly traded and whose value can be readily determined at any point in time. For example, treasury bills, notes, bonds and equities. They are considered to be a current asset as they are held for trading and are expected to be converted into cash in the near term.
Accounts receivable are amounts due to the firm for goods sold on credit for the short term. They are expected to be recovered in the near term. Accounts receivable are always accompanied by a contra account, bad debt expense. As already discussed in a previous post contra accounts set off or reduce the value of the main account to which they are linked. Bad debt expense is the allowance made for credit sales going bad. Therefore accounts receivable are recorded at net realizable value, which is its net value after reducing bad debt expense. Net realizable value is the amount the firm expects to eventually realize from the sales made on credit.
Inventories are either stock of goods held for sale or stock of raw materials held for use in manufacture of goods for sale. Inventories can therefore either be stocks of raw materials, work-in-progress or finished goods. They are included in current assets as they are expected to move off the shelf or get converted into cash within one year or one operating cycle, whichever is greater. Inventories in stock for a period greater than that are indicative of slow moving and obsolete stock.
The cost of inventory includes, cost of purchase, cost of conversion and other costs necessary to bring the inventory to the present condition and location. Cost of inventory however does not include abnormal waste of materials, labor and overheads, storage costs unless they are necessary for the production process, administrative overheads and selling costs.
Most firms use the Standard costing method and Retail method to measure inventory costs. Under standard costing, predetermined amounts of materials, labor and overheads are assigned to goods produced. Under the retail method, inventory is measured at retail prices and gross profit is reduced from it to determine cost.
Accounting standards allow different cost flow assumptions for determining inventory expense on the income statement, such as FIFO and weighted average cost under IFRS and FIFO, LIFO and weighted average cost methods under GAAP. (Read here in detail about the inventory valuation methods already covered in the post on expense recognition).
Prepaid expenses are expenses paid in advance. They are considered to be current assets as they would reduce the expenses in the future accounting periods when they actually fall due. (Read more about the treatment of prepaid expenses here).
Current Liabilities examples
Accounts payable are the amounts owed by the firm to its suppliers for goods purchased on short term credit. They are counted in current liabilities as they are short term credit and expected to come due within one year or one operating cycle, whichever is greater.
Notes payable are amounts owed by the firm to its creditors arising from borrowings against loan agreements. For example, short term bank loans. Notes payable can also be recorded as non-current liabilities if they are for a term of more than one year or one operating cycle, whichever is greater.
Current portion of non-current borrowings
Current portion of non-current borrowings are that portion of the principal of long term borrowings that fall due within one year or one operating cycle, whichever is greater. Therefore they are included in current liabilities.
Current tax payable
Current tax payables are taxes payable within one year that have been recorded on the income statement but have not yet been paid.
Accrued Expenses / Liabilities
Accrued expenses are those that have been recorded on the income statement but have not yet been paid as they are not yet due. They are cash owed for expenses incurred. For example, accrued wages. (Read more about the treatment of accrued expenses here)
Unearned revenue is revenue received for goods yet to be delivered or services yet to be rendered. They are treated as liabilities as they are a liability to the company until the goods are delivered or services are rendered. When the contract is eventually fulfilled revenue is recorded on the income statement and unearned revenue account is reduced. (Read here in detail about the treatment of unearned revenue on financial statements).
With this we come to the end of the post on current assets and current liabilities. Hope you liked the article and will share it …I have embedded below a short ppt summarizing the post….follow the link below it to download it…
In the next post we will cover the non current assets and non current liabilities recorded on the balance sheet…stay posted…
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For solved examples please refer to the CFA Institute books or CFA study notes. The problems can be easily solved using the CFA institute approved financial calculators. Please refer to the CFA exam policy and CFA calculator guide.
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