Current assets are cash and other assets that a company can reasonably expect to convert to cash, sell, or consume within one year or its normal operating cycle, whichever is longer. A company’s normal operating cycle is the average time it needs to go from spending cash to receiving cash. For example, suppose a company uses cash to buy inventory and sells the inventory to a customer on credit. The resulting receivable must be collected in cash before the normal operating cycle ends.
The normal operating cycle for most companies is less than one year, but there are exceptions. For example, because of the length of time it takes The Boeing Company to build aircraft, its normal operating cycle exceeds one year. The inventory used in building the planes is nonetheless considered a current asset because the planes will be sold within the normal operating cycle. Another example is a company that sells on an installment basis. The payments for a television set or a refrigerator can extend over 24 or 36 months, but these receivables are still considered current assets.
Cash is obviously a current asset. Short-term investments, notes and accounts receivable, and inventory that a company expects to convert to cash within the next year or the normal operating cycle are also current assets. On the balance sheet, they are listed in order of their ease of conversion to cash.
Prepaid expenses, such as rent and insurance paid in advance, and inventories of supplies bought for use rather than for sale should be classified as current assets. These assets are current in the sense that if they had not been bought earlier, a current outlay of cash would be needed to obtain them.
In deciding whether an asset is current or noncurrent, the idea of “reasonable expectation” is important. For example, Short-Term Investments, also called Marketable Securities, is an account used for temporary investments, such as U.S. Treasury bills, of “idle” cash—that is, cash that is not immediately required for operating purposes. Management can reasonably expect to sell these securities as cash needs arise over the next year or within the company’s current operating cycle. Investments in securities that management does not expect to sell within the next year and that do not involve the temporary use of idle cash should be shown in the investments category of a classified balance sheet.
This chapter examines five prominent current assets:
- cash and cash equivalents,
- marketable securities,
- accounts receivable,
- inventories, and
- prepaid expenses.
For each asset, we examine the accounting issues and the information contained in the financial statements.
At the end of this chapter, you will know to:
- Identify the items included in cash.
- Understand the need for cash planning and how firms exercise control over cash.
- Comprehend the basic accounting for marketable securities and the limitations of generally accepted accounting principles in this area.
- Determine if a firm is properly managing its accounts receivable.
- Assess if a firm’s allowance for uncollectible accounts is adequate.
- Understand the various inventory cost flow assumptions and the effect that the firm’s choice of inventory method has on its taxes, the quality of information in its financial statements,its management compensation, its loan covenants, and its stock price.
- Analyze a firm’s inventory management practices.
- Understand the nature of prepaid expenses.
Current Assets Contents
- Composition of Cash
- Control of Cash
- Analysis of Cash
- Implications for Managers
- Types of Investments
- Basic Accounting of Marketable Securities
- Analysis of Marketable Securities
- Credit Sales
- Accounting for Credit Sales
- Factoring Accounts Receivable
- Uncollectible Accounts
- Analysis of Accounts Receivable
- Implications for Managers in Accounts Receivable
- Lower-of-Cost-or-Market (LCM) Rule
- Cost Flow Assumptions
- The Choice of Inventory Method
- Valuation of Inventories at Lower of Cost or Market
- The inventories of manufacturers
- Analysis of Inventories
- Comparing LIFO and FIFO Firms