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Chapter 7: Problem 4

How are current assets different from noncurrent assets?

Short Answer

Expert verified
Current assets are assets that a company expects to convert into cash within one year and are typically liquid, including cash, stock inventory, and receivables. On the other hand, non-current assets are assets that have a life of more than one year, can't be easily converted to cash and include items like property, patents, and long-term investments.

Step by step solution

01

Understanding Current Assets

Current assets are the resources that a company expects to convert into cash within one year. They are listed on a company's balance sheet and include cash, accounts receivable, stock inventory, marketable securities, pre-paid liabilities, and other liquid assets.
02

Understanding Non-Current Assets

Non-current assets, also known as fixed assets, are assets that are expected to have a life of more than one year. They cannot be easily converted into cash and they are used over a long term. Non-current assets include property, plant and equipment, patents, trademarks, and long-term investments.
03

Differentiating Current and Non-Current Assets

Current assets differ from noncurrent assets primarily in that they are expected to be converted into cash within one year. Current Assets are typically liquid and can be quickly converted to cash if necessary, while non-current assets are used longer-term and can't be readily converted to cash. Instead, they enable a company's long-term operations and can have a useful life of several years depending on the nature of the asset.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Current Assets
Current assets are a vital part of a company's short-term financial health. These are the resources that companies expect to convert into cash within a year, typically including:
  • Cash: This could be literal cash on hand or funds in a bank account.
  • Accounts Receivable: Money owed to the business by customers for goods or services delivered.
  • Inventory: Stock of goods that are ready for sale.
  • Marketable Securities: Investments that can be easily sold for cash.
  • Prepaid Expenses: Payments made in advance for services that will be received in the future.
Since these assets can be converted into cash relatively quickly, they help companies meet short-term obligations and are crucial for managing day-to-day operations. Tracking current assets gives businesses insights into their liquidity and financial flexibility.
Non-Current Assets
Non-current assets are essential for a company's long-term strategy and operations. Unlike current assets, these are not expected to be converted into cash within a year. Instead, they are resources that usually have a useful life of several years, including:
  • Property, Plant, and Equipment (PPE): Tangible assets like buildings, machinery, and land which are used in production.
  • Intangible Assets: This includes patents, trademarks, and copyrights that protect a company's intellectual property.
  • Long-term Investments: Financial instruments or shares held for more than one year.
Non-current assets, also known as fixed assets, are critical for supporting a company鈥檚 long-term growth and can be a significant portion of a company鈥檚 total assets. They often require substantial investment but provide firms with competitive advantages and operational capabilities over time.
Balance Sheet
The balance sheet is a financial statement that offers a snapshot of a company's financial position at a particular moment in time. It is comprised of three main sections: assets, liabilities, and equity. On the balance sheet:
  • Assets are split into current assets and non-current assets, offering insight into the ease with which assets can be converted to cash.
  • Liabilities are obligations that the company must pay to others. These are also divided into current and non-current liabilities.
  • Equity represents the owner's claims after liabilities are settled.
For investors and creditors, the balance sheet provides essential details about what the company owns and owes, and the owner's investment. A well-balanced sheet is crucial for assessing a firm鈥檚 liquidity, financial health, and ability to sustain operations and growth over time.

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Most popular questions from this chapter

Swen and Jerry are twins who each own an ice cream company. Four years ago, they each purchased an ice cream mixer. Each mixer was identical in all respects, including the cost of \(\$ 35,000\). Each had an estimated useful life of five years and an estimated residual value of \(\$ 5,000\). The only difference between the two mixers was in the depreciation method chosen. Swen chose the straight-line method, whereas Jerry chose the doubledeclining- balance method. Because of the intense competition in the ice cream business and the resulting rapid changes in technology and mixing methods, Swen and Jerry each decided to replace their mixers on the same day at the end of the fourth year. They sold their old mixers to twins Haskin and Dobbins for exactly the same price, \(\$ 10,000\). Later, at a family reunion, Swen mentioned that he had sold his mixer at a loss of \(\$ 1,000 .\) Jerry, while smiling under his beard, said that he had done better than that, and that Swen should check with his accountant because Jerry had realized a gain on the sale of his mixer. Explain how Swen could have had a loss on the sale of the same mixer on which Jerry had a gain. Show the relevant calculations that will convince Swen and Jerry of the accuracy of your analysis.

Discuss the concept of recognizing a gain or loss at the time an asset is sold. Is such a gain or loss a function of good management, or is it a function of improper estimates of residual values? Why do you think that such gains or losses should be shown on the income statement? How do they affect your evaluation of the current year's net income?

A firm purchased computer-aided drafting and machining (CAD-CAM) equipment at the beginning of 1998 for \(\$ 420,000 .\) The machine has an expected use ful life of six years and a \(\$ 38,000\) residual value. Assume that the firm begins the year (before purchasing the CAD-CAM equipment) with the following balance sheet totals: a. Calculate the ending balances in each of these accounts after including the annual double-declining-balance depreciation for the first four years of the equipment's life. Ignore depreciation on the existing plant and equipment. b. After the firm has owned the CAD-CAM machine for six years, what effects would the use of straight-line depreciation versus double-declining-balance depreciation have on the firm's net income? Why?

How does depletion of natural resources affect cash flows? When does cash change as a result of transactions involving natural resources?

Discuss the differences between the full cost method and the successful efforts methods when accounting for natural resources. Why might large firms prefer one method and small firms the other?
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