LO 4.6 Define, Explain, and Provide Examples of Current and Noncurrent Assets, Current and Noncurrent Liabilities

In the section Prepare Financial Statements Using the Adjusted Trial Balance you used the adjusted trial balance to prepare financial statements, including an income statement, statement of retained earnings, and balance sheet, for Printing Plus.  The balance sheet was prepared using the report form and was not classified.  In this section, we will continue to use Printing Plus’s Adjusted Trial Balance as of January 31, 2019, but this time we will prepare a classified balance sheet using the account form.  You will see that total assets, total liabilities and total equity remain the same, but the layout and subtotals will be different.  Before we can prepare a classified balance sheet, you need to know about the classifications we find useful for assets and liabilities.

In accounting, we classify assets based on whether or not the asset will be converted to cash or consumed within a certain period of time, generally one year. If the asset will be converted to cash or consumed in one year or less, we classify the asset as a current asset. If the asset will not be converted to cash or consumed within a  year, we classify the asset as a noncurrent asset.  Take a look at Printing Plus’s Adjusted Trial Balance and focus on its assets.  Which of the assets would Printing Plus be likely to receive cash for, or use up within one year?

Since Cash is already cash, it is always considered to be a current asset.  Generally, we would expect to receive cash from our Accounts Receivable within 30 to 60 days, so Accounts Receivable is a current asset.  As long as we expect to receive our interest within a year, Interest Receivable is a current asset.  Supplies is a little different in that we do not expect to receive cash for our supplies at any time.  But we do expect to consume or use up our supplies, generally within a year.  So Supplies is a current asset.  Then we come to Equipment.  We assume that Printing Plus plans to use the equipment over multiple years, so Equipment is a noncurrent asset.  (The Accumulated Depreciation account will move with  the Equipment account into the balance sheet.)

One more thing about asset classifications — sometimes we find it useful to organize noncurrent assets into groups, including Plant and Equipment, Investments, and Intangible Assets.  The Plant and Equipment category includes vehicles, land, buildings, and equipment that are used in the business’s operations.  Investments can include stocks or bonds (issued by other corporations) or land or buildings held for investment purposes, not for use in operations.  An intangible asset is one that lacks physical substance—it cannot be touched or moved. Examples of intangible assets include trademarks, copyrights, patents and something called goodwill.

Similar to the accounting for assets, liabilities are classified based on the time frame in which the liabilities are expected to be paid or settled. A liability that will be paid or settled in one year or less (generally) is classified as a current liability, while a liability that is expected to be paid in more than one year is classified as a noncurrent liability.

Which of Printing Plus’s liabilities will require payment or settlement within a year?  Accounts payable, amounts the company owes to suppliers, are almost always due within 30 to 60 days.  So Accounts Payable is a current liability.  Salaries Payable is also a current liability, because the salaries will have to be paid on the next pay day.  Unearned revenue (cash the company received from a client before the company provided and services) is usually a current liability, since the services are usually due to be provided within a year.  So Printing Plus has no noncurrent liabilities, but some examples of amounts the company might owe, but not have to pay for more than one year, are notes payable and bonds payable with maturity dates that extend beyond a year.

Why Does Current versus Noncurrent Matter?

Because the timing of receiving cash and paying cash is critical for businesses, a balance sheet that shows both current assets and current liabilities is useful.  When a balance sheet subdivides assets and liabilities into current and noncurrent sections, it’s called a classified balance sheet.  We will prepare a classified balance sheet for Printing Plus, but we need to clarify one more point first.  Any balance sheet, whether classified or not, can be laid out in either of two ways — we can use either the report form or the account form.  Both forms display the accounting equation (assets = liabilities + equity).  But the report form displays the equation vertically, whereas the account form displays the equation horizontally.  Here’s an illustration of the two forms:

Regardless of which form you use, total assets must equal total liabilities and equity.  You have already seen the (unclassified) report form of Printing Plus’s balance sheet.  Now we’ll show you the classified, account form of the balance sheet:

Notice that Total Assets is still $29,965, Total Liabilities is still $5,400, and Total Equity is still $24,565, just like we saw in the report form, unclassified balance sheet.  But now we can easily compare the company’s current assets, $26,540, to it’s current liabilities, $5,400 and surmise that Printing Plus should be able to pay or settle its current liabilities without difficulty.  When we compare current assets to current liabilities, we are evaluating a company’s liquidity.

Liquidity Ratios

In addition to reviewing the financial statements in order to make decisions, owners and other stakeholders may also utilize financial ratios to assess the financial health of the organization. While a more in-depth discussion of financial ratios occurs in Appendix A: Financial Statement Analysis, here we introduce liquidity ratios, a common, easy, and useful way to analyze the financial statements.

Liquidity refers to the business’s ability to convert assets into cash in order to meet short-term cash needs. Examples of the most liquid assets include accounts receivable and inventory for merchandising or manufacturing businesses. The reason these are among the most liquid assets is that these assets will be turned into cash more quickly than land or buildings, for example. Accounts receivable represents goods or services that have already been sold and will typically be collected within thirty to forty-five days. Inventory is less liquid than accounts receivable because the product must first be sold before it generates cash (either through a cash sale or sale on account). Inventory is, however, more liquid than land or buildings because, under most circumstances, it is easier and quicker for a business to find someone to purchase its goods than it is to find a buyer for land or buildings.