Short and long-term classification of certain assets and liabilities (Part II)

April 23, 2013

In a classified balance sheet, current (short-term) and non-current (long-term) assets and liabilities are presented separately. In most cases current assets and liabilities are easy to distinguish and don’t present any issues with their classification and presentation on a balance sheet. However, there are certain items which may require special treatment because they need to be separated into the current and non-current portions. In the second part of this article we will discuss two items: deferred rents and notes payable.

1. Current and non-current portions of deferred rents

Note: This is the second part of the two-part article. For the first part, refer to Short and long-term classification of certain assets and liabilities (Part I).

The deferred rents balance represents a deferred rent liability resulting from straight-lining lease expense for the company’s office rent. The entire balance of $153 is included in current liabilities on the balance sheet. The following information pertains to the lease:

Lease start date

6/1/20X3

Lease end date

5/31/20X6

Lease term

3 years (36 months)

Lease payments:
   Months 1-6
   Months 7-12
   Months 13-24
   Months 25-36


$0
$22
$30
$34

Lease classification

Operating lease

The lease payments increase over the lease term, so they represent escalating lease payments. According to US GAAP, lease expense under such lease agreements should be recorded on a straight-line basis. For more information about this topic, refer to article on accounting for escalating lease payments or rent holidays.

As shown in the table below, the total lease expense over the lease term will be $900. This implies that the average monthly lease expense is $25 (i.e., 900 ÷ 36 months). The difference between the monthly lease expense and monthly lease payment represents deferred rents. Deferred rents in our example have a credit balance and thus are recorded as a liability. The following table presents monthly lease expenses and deferred rents for the lease term:

Date

Month

Rent
Expense

Rent
Payment

Monthly
Deferred
Rent

Cumulative
Deferred
Rent

Jun 20X3

1

$25

$0

$25

$25

Jul 20X3

2

25

0

25

50

Aug 20X3

3

25

0

25

75

Sep 20X3

4

25

0

25

100

Oct 20X3

5

25

0

25

125

Nov 20X3

6

25

0

25

150

Dec 20X3

7

25

22

3

153

Jan 20X4

8

25

22

3

156

Feb 20X4

9

25

22

3

159

Mar 20X4

10

25

22

3

162

Apr 20X4

11

25

22

3

165

May 20X4

12

25

22

3

168

Jun 20X4

13

25

30

(5)

163

Jul 20X4

14

25

30

(5)

158

Aug 20X4

15

25

30

(5)

153

Sep 20X4

16

25

30

(5)

148

Oct 20X4

17

25

30

(5)

143

Nov 20X4

18

25

30

(5)

138

Dec 20X4

19

25

30

(5)

133

Jan 20X5

20

25

30

(5)

128

Feb 20X5

21

25

30

(5)

123

Mar 20X5

22

25

30

(5)

118

Apr 20X5

23

25

30

(5)

113

May 20X5

24

25

30

(5)

108

Jun 20X5

25

25

34

(9)

99

Jul 20X5

26

25

34

(9)

90

Aug 20X5

27

25

34

(9)

81

Sep 20X5

28

25

34

(9)

72

Oct 20X5

29

25

34

(9)

63

Nov 20X5

30

25

34

(9)

54

Dec 20X5

31

25

34

(9)

45

Jan 20X6

32

25

34

(9)

36

Feb 20X6

33

25

34

(9)

27

Mar 20X6

34

25

34

(9)

18

Apr 20X6

35

25

34

(9)

9

May 20X6

36

25

34

(9)

0

Total

 

900

900

0

 

The last column in the table shows the cumulative deferred rent liability. As of December 20X3, the deferred rents balance was $153 (highlighted in light blue). This amount will continue to grow until June 20X4 - when the monthly deferred rent will change to a negative $5 and the cumulative deferred rent liability will start decreasing. By December 20X4 the deferred rents balance will decrease to $133. So, over the 12 months after the balance sheet date $20 (i.e., $153 - $133) of deferred rent balance will be liquidated (“used”). This $20 represents the current portion of deferred rent liability. The monthly deferred rents over the 12 months period which comprise the $20 are highlighted in light orange in the table.

The monthly deferred rent amounts after December 20X4 represent the non-current (long-term) portion of the deferred rent liability because they will not be liquidated (“used”) within the 12 months after the balance sheet date. The total of such amounts is $133 and these amounts are highlighted in light green in the table above.

To summarize, the 12/31/20X3 deferred rent balance of $153 should be split into the current portion (i.e., $20) and non-current portion (i.e., $133) and an adjustment should be made on the balance sheet.

The balance sheet with this adjustment is presented below. Note that a new element is now shown on the balance sheet for the long-term portion of the deferred rent liability. This element is presented after the long-term note payable line and is titled Other Liabilities (highlighted in yellow on the balance sheet below):

Friends Company
Consolidated Balance Sheet as of December 31, 20X3

ASSETS

Current assets:

 

   Cash and cash equivalents

$3,300

   Accounts receivable

2,900

   Inventories

2,600

   Prepaid expenses

48

      Total current assets

8,848

Property, plant and equipment:

 

   Buildings

5,000

   Machinery, equipment

8,720

      Less: Allowance for depreciation

(5,500)

   Property, plant and equipment (net)

8,220

Other assets

76

      Total Assets

17,144

LIABILITIES AND STOCKHOLDER'S EQUITY

Current liabilities:

 

   Accounts payable

1,600

   Accrued expenses

1,200

   Income taxes payable

900

   Deferred rents

20

      Total current liabilities

3,720

Long-term note payable

3,953

Other liabilities

133

Stockholder's equity:

 

   Common stock

1,000

   Paid-in capital

1,850

   Retained earnings

6,488

      Total stockholder's equity

9,338

      Total Liabilities and stockholder's equity

17,144

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