Question

Short-term deferrals (prepaids and unearned revenues) are classified as current assets and current liabilities. As such, they are included in working capital.

Required:

Some argue that deferred liabilities will not be “paid”.

1)      Why do accountants include short-term unearned revenues as current liabilities? Do they meet the definition of liabilities found in the conceptual framework? Do they affect working capital? Explain. 5 marks

2)      Present arguments for excluding unearned revenues from current liabilities. Do they affect liquidity? Explain. 5 marks

Answer 1

1. All business transactions need not necessarily happen within a particular financial year. Some may be pertaining to the previous and some to the next. Accordingly the business may receive monies from customers as "advance" payments. The services corresponding to these advances may be performed in the upcoming period. Hence they are termed as Unearned Revenues. Hence since the financial benefit is received by the business they have an obligation to perform their part of contract in future time or refund such monies received as advance with or without interest. Both ways the business have liability. Since such liabilities have to met in the following financial year ie within 12 months from the date (usually), they are considered as Short term Liability.

Thus they meet the framework to be called liability. Since all current liabilities form a part of computation or working capital, unearned revenues also shall be a part of it.

2. The argument is that such unearned revenues do not have any realizable value. Thus they do not help in payment of any debts. Thus it is also right to say they do not provide any liquidity.