Financial accounting and auditing Lecture 9 Current assets

Financial accounting and auditing Lecture 9 Current assets

Outline • • A current asset The working capital Inventories Receivables Prepayments Investments Cash

A current asset • A current asset is an asset that satisfies any of the following criteria: • (a) it is expected to be realised in, or is intended for sale or consumption in, the entity’s normal operating cycle; • (b) it is held primarily for the purpose of being traded; • (c) it is expected to be realised within twelve months after the reporting period; • (d) it is cash or a cash equivalent.

Examples raw materials work in progress finished goods trade receivables (debtors) amounts owed by other companies in a group prepayments and accrued income investments held as current assets short-term bank deposits bank current account (also called ‘cash at bank’) cash in hand.

The working capital • Working capital is the amount of long-term finance the business has to provide in order to keep current assets working for the business. • Some short-term finance for current assets is provided by the suppliers who give credit by allowing time to pay.

The working capital • Working capital is the amount which a business must provide to finance the current assets of a business, to the extent that these are not covered by current liabilities. It is calculated by deducting current liabilities from current assets.

The working capital cycle for a manufacturing or service business Inventories (stocks) Receivable s Payables Cash

Inventories are assets: • (a) held for sale in the ordinary course of business; • (b) in the process of production for sale; or • (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Receivables • Debtors are those persons who owe money to a business. • Trade receivables relates to customers buying goods on credit

Trade receivable • Trade receivables (debtors) meet the recognition conditions because there is an expectation of benefit when the customer pays. The profit on the sale of the goods is known because the customer has taken the goods or service and agreed the price. • Trade receivables (debtors) are therefore measured at the selling price of the goods and the profit is recognized in the income statement (profit and loss account). There is a risk that the customer will not pay, but the view taken is that the risk of nonpayment should be seen quite separately from the risk of not making a profit on a sale.

Prepayments • Prepayment an amount paid for in advance for an benefit to the business, such as insurance premiums or rent in advance. Initially recognized as an asset, then transferred to expense in the period when the benefit is enjoyed.

Investments • Investments held as current assets are usually highly marketable and readily convertible into cash. The expectation of future economic benefit meet the conditions of recognition. • There are two possible measures. One is the cost of the investment and the other is the market value. Recognizing the investment at cost is prudent and reliable, but not as relevant as the current market value which is the amount of cash that could be released by sale of the investment.

Cash • Recognising cash is no problem either in the expectation of benefit or in the measurement of the asset. The amount is known either by counting cash in hand or by looking at a statement from the bank which is holding the business bank account. • The expectation of benefit lies in making use of the cash in future to buy fixed assets or to contribute to the working capital cycle so that the business earns a profit. In the meantime, cash which is surplus to immediate requirements should be deposited in • such a way that it is earning interest. Where a company has substantial cash balances there should be indications in the income statement (profit and loss account) that investment income has been earned, to provide a benefit to the business.