Question

In its annual report 1999, Roche, the Swiss pharmaceuticals company provides for the following information relating to the balance sheet item ‘other current assets’: Other current assets (in millions of Swiss francs): 1999 1998 Accrued interest income 127 54 Prepaid expenses 1,122 536 (…) Total other current assets 2,633 1,469 Required Explain what the ‘accrued interest income’ represents. Illustrate your explanation showing with your own figures the impact of the adjusting entry on the financial statements. Explain what the ‘prepaid expenses’ represent. Provide examples of prepaid expenses a company such as Roche could have reported. Illustrate your explanation showing, with your own figures, the impact of the adjusting entries on the financial statements.

Answer 1

An accured interest income is the part of the interest that has been earned by Roche over the period, but has not been paid for by the bank or the firm in which Roche has parked its money. Roche could have invested a part of its cash surplus in a fixed deposit in a bank for a maturity period of 5 years, so for each year that fixed deposit earns an interest but is not paid for by the bank since it will be paid at the end of 5 years. This interest earned each year is reflected in the books as accrued interest.
For example, if accrued interest is $1000
This adjustment entry increases the revenue for the company by increase in other income of $1000. However this gets adjusted in the operating cash flow by a decrease in cash to the tune of increase in current assets of $1000
Credit - $1000 - Impacts revenue - income
Debit - Accrued interest - $1000 - impacts balance sheet assets
Credit - Cash - $1000 - impacts balance sheet assets

A prepaid expense could be an advance payment for an expense which could be incurred next year such as painting of office. Since payment has been made in advance, so Roche do not have to make any further payment next year when the actual service would be performed. This would again lead to reduction in cash balance and an increase in other current assets.

For example, if prepaid expense is $1000
This adjustment entry decreases cash of the company by $1000.
Credit - $1000 - Impacts cash - balance sheet
Debit - Prepaid expense- $1000 - impacts balance sheet assets