Typical Transaction 4
Example: 15,600 Additional Rent and Insurance Prepayment
|Prepayment for Office Costs and Insurance||Decrease Asset (Cash at Bank) (-)|
|Increase Asset (Prepayments) (+)|
> Double entry: Debit entry, Debtors and Prepayments balance increases from 9,300 to -24,900. Credit entry, Cash at Bank balance decreases from -767,850 to 742,950
> Values in red show Balance sheet values before and after changes
|Debtors and Prepayments||9,300||24,900|
|Other Current Assets (Stock)||0||0|
|Long Term Liabilities||0||0|
|Long Term Loan||0||0|
|TOTAL Liabilities + Equity + Retained Earnings||811,850||811,850|
An analysis of financial ratios can be seen here.
Current ratio calculations are as follows:
|Cash at Bank||3 months rent Debtors and Prepayments||Current Assets||Liabilities||Current Ratio|
|Balance Sheet Original||758,550||9,300||767,850||44,300||767,850 / 44,300 = 17.3|
|Balance Sheet New||742,950||24,900||767,850||44,300||767,850 / 44,300 = 17.3|
The increase in prepayment does not change the current ratio as Cash at Bank diminishes by 15,600 but simultaneously Debtors and Prepayment increases by the same amount. In the Accounting system it can be seen that the entries for this typical transaction are both on the asset side on the B/S, without any change on the liabilities and equity side. Therefore, Current Assets do not change.
Creditors nor Accruals change, thus, Current Liabilities do not change. Current ratio remains the same before and after this transaction.
However, a higher expense in prepayments may cause a cash problem Cash at Bank has been reduced from 758,550 in the initial B/S down to 742,950 in the new B/S, if there are pending payment obligations and the cash is diverted to higher prepayments. Prepayments need careful cash monitoring to avoid running into cash deficit problems.