Case 8-10 Accounting for prepaid and Deferrals Short-term defferals (prepaid and unearned revenues) are classifies

as current assets an current liabilities. As such, they are included in working capital. Required: a. Some argue that prepaid will not generate cash and hence are not liquid assets. i. Why do accountants include short0term prepaid as current assets ? do the meet the definition pf assets found in the conceptual framework ? do they provide working capital? Explain.

ii. Present argyments for excluding prepaids from current assets. Do they provide liquidity? Explain. b. Some argue that defferedn liabilitites will not be paid i. Why do accountants include short-term unearned revenues as current liabilities ? do they meet the definition of liabilities found in the conceptual framework ? do they affect working capital ? Explain.

c. Present arguments for excluding unearned revenues from current liabilities. Do the affect liquidity? Explain

Answer:

a.

i. Cash flow statements are an important part of a company's financial statements. cash flow statement provides a snapshot of money coming into and going out of the company's budget. Its importance lies in the fact that it can be used as a tool to predict future cash flow, based on previous spending and income. Cash flow statements contain all kinds of useful information, including information regarding the disposal of assets. As with other financial transactions, assets that have been disposed of must be accounted for properly using generally accepted accounting principles. ii. Liquidity refers to the readiness of assets to be converted to cash. By comparing a company's liquid assets with its short-term obligations, we can obtain a general idea of the firm's ability to pay its short-term debts as they come due. Usually, current assets are thought of as the most liquid of a company's assets. Obviously, though, some are more liquid than others, so it's important also to evaluate the specific makeup of current assets. Two common

measures of liquidity are (1) the current ratio and (2) the acid-test ratio (or quick ratio) calculated as follows :

CURRENT RATIO. Implicit in the definition of a current liability is the relationship between current assets and current liabilities. The difference between current assets and current liabilities is called working calotal (differences between current assets and current liabilities) . By comparing a company's obligations that will shortly become due with the company's cash and other assets that, by definition, are expected to shortly be converted to cash, the analysis offers some indication as to ability to pay those debts. Although used in a variety of decisions, it is particularly useful to those considering whether to extend short-term credit. The current ratio (current assets divided by current liabilities) . is computed by dividing current assets by current liabilities. A current ratio of 2 indicates that the company has twice as many current assets available as current liabilities. b. Current liabilities are ones the company expects to settle within 12 months of the date on the balance sheet. Settlement comes either from the use of current assets such as cash on hand or from the current sale of inventory. Settlement can also come from swapping out one current liability for another. At present, most liabilities show up on the balance sheet at historic cost rather than fair value. And theres no GAAP requirement for the order in which they show up on the balance sheet, as long as they are properly classified as current. The big-dog current liabilities, which youre more than likely familiar with from previous accounting classes, are accounts payable, notes payable, and unearned income. Keep in mind that any money a company owes its employees (wages payable) or the government for payroll taxes (taxes payable) is a current liability, too c. Unearned revenue is cash received by a business for goods or services yet to be provided. It is recorded as a liability on the businesss balance sheet until the contract is completed. Unearned revenue can be accrued in a variety of different ways. For example, a one-year gym membership. When this right is purchased, the gym would get the cash for a year of service it has yet to provide. So when the cash is originally received, it will be recorded as unearned revenue. As each month passes a portion of that unearned revenue will be reclassified as earned, given that the service, a month of gym usage, will be provided. Unearned revenue that will be earned within the year and thus pay off the liability, is a current liability