Cash, receivables & Prepaid expenses

Overview

• Discussion of important balance sheet line items with focus on cash and equivalents, accounts receivable, and prepaid expenses.

Cash and Equivalents

• Definition: Cash and equivalents represent extremely liquid assets.

• Examples:

  • US Treasury bills with a maturity of less than or equal to 90 days.

  • Marketable securities that are debt or equity investments held by a company.

• Categorization:

  • All cash and equivalents might be aggregated in reporting or may be separately identified.

• Characteristics:

  • Not just cash: Includes anything easily convertibly to cash (e.g., money market accounts, short-term US Treasuries).

• Case Example (Walmart):

  • Total cash and equivalents amounting to approximately $6,500,000,000.

• Footnote Disclosure:

  • Investments with a maturity of three months or less are classified as cash equivalents.

  • Transactions processed within seven days (credit card, debit card, electronic benefit transfer) are classified as cash and cash equivalents.

  • Inclusion of restricted cash related to cash collateral holdings.

Accounts Receivable

• Definition: Accounts receivable consists of sales made on credit where the cash has not yet been received for the products sold and delivered.

• Importance: Represents a significant line item for companies, indicating money owed.

• Components for Walmart:

  • Includes substantial amounts due from insurance companies, particularly from pharmacy sales where Walmart waits to be reimbursed for prescription drugs after deductibles and co-pays.

• Transition of Accounts:

  • Transactions via customer credit cards, debit cards, and electronic bank transfers exceeding seven days transition from cash equivalents to receivables due to processing time.

• Relationship With Revenue:

  • Accounts receivable is linked to revenue in the income statement.

• Example Scenario:

  • A book publisher sells books totaling $1,000, of which $800 has been collected in cash, and $200 is due in 14 days.

  • Under accrual accounting principles:

  • Recognize full revenue:

    • Journal Entries:

    • Debit Cash: $800

    • Credit Revenue: $1,000 (recognizing total earned revenue leading to credit in retained earnings by $1,000)

    • New Accounts Receivable: $200

Prepaid Expenses

• Definition: Prepaid expenses are payments made in advance for services to be received in the future and do not impact the income statement immediately.

• Characteristics:

• Although they have "expenses" in their name, they are recorded as assets until the service is utilized.

• Example (Procter & Gamble):

  • Reported prepaid expenses of approximately $3,600,000,000.

• Concept Explanation:

  • Accrual accounting recognizes expenses when the corresponding benefit is received, not at payment.

• Scenario Example:

  • A company prepays $5,000 to cover utilities for 12 months.

  • Journal Entries:

  • Prepayment Day:

    • Debit Prepaid Expenses $5,000

    • Credit Cash $5,000

  • After Six Months (Utilities Consumed):

    • Debit Utilities Expense $2,500 (recognized on the income statement)

    • Credit Prepaid Expenses $2,500 (reducing the asset to represent consumed utility service)

• Final Assessment (End of Year):

  • By year-end, all $5,000 in utilities will be recorded as utilities expenses, fully utilizing the prepaid asset.