Prepaid Expenses and Other Current Assets on the Balance Sheet
Lessons in balance sheet analysis
While reviewing a company's balance sheet, you'll likely notice a current assets section at the top. Within this category, companies have some fairly standard accounts which act as placeholders for assets the company expects to generally either receive or use up within one year.
This includes prepaid expenses, along with other typical current asset accounts such as cash and equivalents, accounts receivable and inventory.
Expenses in the Prepaid Expenses Account
In the course of everyday operating activities, many firms will end up paying for goods or services before they actually receive delivery of them. This includes items like employee labor, which the company records into a prepaid salaries account until it cuts paychecks.
Companies pre-pay many other types of expenses including taxes, utility bills, rents, insurance, and interest expense. These may be pooled together and listed on the balance sheet under one "prepaid expenses" heading, although each prepaid item is typically maintained in its own account within the company's general ledger accounting system.
Prepaid Expense Example
Say a jewelry store moved into your local mall, signed a rental agreement and paid six to twelve months of rent in advance. If the monthly rent was $2,000 and the business prepaid for an entire year, the store would show the $24,000 payment on its balance sheet under Prepaid Expenses ($2,000 monthly rent x 12 months = $24,000).
Each month, it would deduct 1/12 from the prepaid expenses, transferring it to a rent expense line on the income statement. By the end of the year, the full $24,000 would have been expenses on the income statement, and there would be $0 left in the prepaid expense asset account shown in the current asset section of the balance sheet.
Prepaid Expenses and Risk
Depending on what a prepayment covers, you might be exposed to a degree of risk if the other party never delivers. If the jewelry store mentioned above paid a full year's rent, for example, and the landlord evicted them after 6 months but kept all of their money.
Unless there is a legal requirement requiring the payment recipient to keep the prepaid funds in a segregated escrow account, if the firm or individual went bankrupt it might not be in a position to deliver the goods or services for which the purchaser had already paid.
In this situation, it would convert the person or firm making the prepayment into a general creditor who had to get in line with other creditors to wait for a payment distribution during a bankruptcy proceeding.
Other Current Assets on the Balance Sheet
Other current assets consist of assets that are either owed to the company within one year or will likely be used within one year. Aside from prepaid expenses, this includes the following:
- Cash and equivalents: Includes the company's cash in bank accounts, received but undeposited checks, savings and money market accounts, and highly-liquid investments with a 3-month or less maturity, such as Treasury bills.
- Accounts Receivable: Payments not yet received from customers for sales made on credit terms.
- Notes Receivable: Debts owed to the company, payable within one year. The remaining portion of the note, if longer than one year, resides in the long-term assets section of the balance sheet.
- Inventories: For non-service companies, this account contains components that haven't yet been converted into products and finished goods that haven't yet been sold to customers.
Non-Standard Items on the Balance Sheet
Sometimes companies put items on their balance sheet which aren't standard; perhaps resulting from one-off unique situations which the company explains in its financial statements and footnotes, found in its 10-K filing.
Take these on a case-by-case basis to try and determine the role they play in the company's overall financial picture. As you gain more experience analyzing balance sheets, you'll start to see certain patterns and terms arise from time to time, particularly within a given industry.