Accounting Theory Question
Case 8- 10 Accounting for Prepaids and Deferrals
Short term deferrals (prepaid and unearned revenues) are classified as current assets and current liabilities. As such included in working capital.
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.
2. Present arguments for excluding unearned revenues from current liabilities. Do they affect liquidity? Explain.
Unearned income, or deferred income, normally speaks to an organization's present obligation and influences its working capital by diminishing it. Unearned income is recorded when a firm gets a loan from its client in return for items and services that are to be given in the future. Since an organization can't perceive income on this loan and it owes cash to a client, it must record a current liability for any part of the loan for which it hopes to provide services within a year. Since current liabilities are a part of the working capital, a present balance of unearned income decreases an organization's working capital.
Unearned income regularly emerges when an organization receives compensation it despite everything needs to give items to which the payment was made. Consider a media organization that requests that its clients pay $120 in advance for yearly subscriptions to its month to month magazine. At the point when a client sends a $100 payment, the media organization records a $100 debit to its cash balance and a $100 credit to its unearned revenue account. At the point when the organization ships magazines to a client once every month, it can diminish its unearned income by $10 by recording a debit to the unearned income account and a $10 credit to its income account or revenue account.
Working capital is the distinction between an organization's current assets and its current liabilities, which it records on its balance sheet. On the off chance that an organization has an equalization of earned income for administrations it expects to give within a year, this balance is viewed as a current liability and would diminish the working capital.
Money is excluded from working capital, particularly in huge amounts, is invested by firms in treasury bills, transient government securities or business paper. ... In contrast to stock, account receivables and other current assets, money at that point gains a reasonable return and ought not be included in measures of working capital.