Short and long-term classification of certain assets and liabilities (Part I)
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 first part of this article we will discuss one of such items: prepaid insurance.
1. Definition of short-term (current) and long-term (non-current)
Note: This is the first part of the two-part article. For the second part, refer to Short and long-term classification of certain assets and liabilities (Part II).
In a classified balance sheet, current (short-term) and non-current (long-term) assets and liabilities are presented separately. Current items are shown first on the balance sheet: current assets are followed by non-current assets and current liabilities are followed by non-current liabilities. Let’s recall what current assets and liabilities are.
Current assets are cash and other resources that are reasonably expected to be realized in cash or sold or consumed within one year of the balance sheet date or the entity's operating cycle, whichever is greater.
Assets other than current ones are considered non-current assets.
Current liabilities are obligations that are reasonably expected to be paid from existing current assets or through the creation of other current liabilities.
Liabilities other than current ones are considered non-current liabilities.
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 this article, we will cover three such items:
- prepaid assets,
- deferred rents, and
- notes payable.
We will use the following balance sheet as a starting point in our discussion of the three items (note: we are using small numbers in this article for ease of calculation; in real life numbers may be larger):
Friends
Company |
|
ASSETS |
|
Current assets: |
|
Cash and cash equivalents |
$ 3,300 |
Accounts receivable |
2,900 |
Inventories |
2,600 |
Prepaid expenses |
124 |
Total current assets |
8,924 |
Property, plant and equipment: |
|
Buildings |
5,000 |
Machinery, equipment |
8,720 |
Less: Allowance for depreciation |
(5,500) |
Property, plant and equipment (net) |
8,220 |
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 |
153 |
Total current liabilities |
3,853 |
Long-term note payable |
3,953 |
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 |
The current fiscal year end is 12/31/20X3.
Prepaid expenses represent an insurance premium paid during 20X3 which covers three years. The prepaid expenses balance is included in current assets on the balance sheet.
Deferred rents represent an accrued rent liability from straight-lining lease expenses for the company’s office rent. The lease term started in 20X3 and the lease agreement is for three years. The deferred rents are included in current liabilities on the balance sheet.
The note payable represents the company’s long-term obligation (i.e., bank loan). This loan was obtained during 20X3 and its maturity date is in 20X6. The loan requires monthly payments consisting of principal and interest. The loan balance is presented as a non-current liability on the balance sheet.
On the surface, all three items are correctly classified on the balance sheet: prepaid expenses are classified as a current asset, deferred rents – as a current liability, and note payable – as a non-current liability. However, further analysis will show that only a portion of these items is classified correctly.
We will look at each item separately and provide an updated balance sheet showing the corrected presentation for each of them.
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