Week 2: The Accounting System and

Accrual Accounting - Discussion

Prepaid Expenses vs. Unearned Revenue (graded)
From this week's reading, you were introduced to the concept of unearned revenue and prepaid expenses.
Imagine that you are CFO of a company that manufacturers picture frames. Your company wants to become
more vertically integrated, meaning it no longer wants to purchase the products that go into the frame, but
rather manufacture them. To do this, your company has decided to acquire a glass manufacturing company.
There are two glass manufacturers that your company is deciding between: Glass R' US and Glass Team. In
reviewing the balance sheet of each company, you noticed the following:
a. Glass R' US has a large amount of Unearned Revenue and no Prepaid Expenses.
b. Glass Team has a large amount of Prepaid Expenses and no Unearned Revenue
In your discussion post, explain what unearned revenue and prepaid expenses represent. Then, basing your
decision solely on the amount of unearned revenue and prepaid expenses each company has, tell us which
company you would acquire and why? (In answering "why", be sure to include why you believe that company's
position is superior. For example, "I believe having a large amount of prepaid expenses is a better position
because ....")

Responses
Response

Author

Date/Time

As you
respond .. Professor Thomas
.

9/9/2012 12:33:23 PM

Consider the reasons why a company may acquire another company and what aspects
of the acquired company will provide benefits. For example, if you were to acquire a
company, would aspects would you focus on the most ... the amount of cash the
company holds; if it has high or low expenses; the future revenue that you know it will
earn; how committed and loyal the company's existing customers are; etc ...

Prepaid
Expenses
vs.
Unearned
Revenue

Amirah Howard

9/11/2012 11:16:35 AM

I would go with b. The Glass Team which has a large amount of Prepaid Expenses and
no Unearned Revenue, because the company already paid on accounts and is
considered as an asset. I think so, this was a little confusing.

RE:
Prepaid
Expenses
Professor Thomas
vs.
Unearned
Revenue

9/12/2012 7:56:59 PM

Hi Amirah,
You are correct in noting that prepaid expenses represent when a company
has paid for an expense (service) but has not used them yet. In this case, they
are considered assets.

Prepaid
Expenses
vs.
Unearned
Revenue

Marie Roberts

9/12/2012 9:53:30 AM

Unearned revenue represents money that is received before revenue is

earned. It is usually consider a liability. Prepaid expenses represents money
that is paid before an expense is incurred. It is usually considered an asset.
In light of this, I believe that if I were the CFO of a company, I would make

a decision to acquire Glass Team. Glass Team has a large amount of Prepaid
Expenses which means that there is a lot of asset. There is no Unearned
Revenue so there is no liability. It is my opinion, that Glass Team would add
value to my company and would be a better choice.

RE:
Prepaid
Expenses
Professor Thomas
vs.
Unearned
Revenue

9/12/2012 7:57:48 PM

Great explanations of unearned revenue and prepaid expenses!

Prepaid
Expenses
vs.
Unearned
Revenue

Bruce Burbank

9/12/2012 7:03:52 PM

The definition of unearned revenue is cash received up front for work yet to be
performed and prepaid expenses represent items paid in advance, such as rent, utilities
and insurance are some examples of prepaid expenses. I would buy a company with a
large amount of prepaid expenses, because they don't have a lot of outside vendors
who will be expecting future services. Glass Team would be a smarter choose in my
analysis of the two companies, furthermore having a large prepaid expense shows you
have earned revenue and are investing into future business opportunities and plan on
being around for the future. This company represents a solid investment.

RE:
Prepaid
Expenses
Professor Thomas
vs.
Unearned
Revenue

9/12/2012 8:03:05 PM

Good comment Bruce. The one thing I would add on is that prepaid expense
are paid with cash. Cash can be generated through revenue (i.e.: i sold some
goods to a customer and was paid cash) or it can come from other sources
such as taking out debt or an investor contributing money (i.e.: the company
takes out 10,000 in debt and uses the case to prepay expenses.). The latter is
unlikely or would not be a good business practice, but it is possible.
Most likely (and hopefully), the company is paying for prepaid expenses with

excess cash they have. Any thoughts on what could be some disadvantages to
prepaying expenses?

RE:
Prepaid
Expenses
Bruce Burbank
vs.
Unearned
Revenue

9/13/2012 2:59:10 PM

Professor Thomas,
Some of the disadvantages of prepaying expenses have to do with
factors outside of your control, for instance prepaid rent on a facility
for 6 months. If there is a fire and you can not utilize that facility
anymore, that is not a immediately recoverable expenses, because
now you have to setup shop in another location until repaired, if
possible. If you have prepaid and need to expand quickly to another
location or your business shrinks and you don't need as much space.
If there are investors who want to liquidate their shares and you have
tied large revenue into prepaid can cause an issue. These are a few
examples I can think of at this time.

RE:
Prepaid
Expenses
Dimitra Arrieta
vs.
Unearned
Revenue

9/13/2012 10:33:42 PM

You are so right Bruce when you say that there is a

disadvantage of prepaying expenses sometimes where there
is factors outside our control. Unexpected things happen
and if you prepay you will not have the money in the event
you do need to setup somewhere else.

RE:
Prepaid
Expenses
Professor Thomas
vs.
Unearned
Revenue
Hi Bruce (class),

9/14/2012 7:47:55 AM

One disadvantage of prepaying expenses is "opportunity

costs". Think about it in terms of the company expending
cash on expenses ("services") that they have not used yet. If
the company didn't spend the cash on prepaying expenses,
what could they have done with the money instead? (the
opportunity costs of spending money prepaying expenses
rather than doing something else.)
Class,
Does anyone have thoughts on this? What could they do
with the money instead of prepaying expenses? Also, when
may a company want to prepay expenses? (Think about
interest rates ... or investment opportunities)

RE:
Prepaid
Expenses
vs.
Bruce Burbank
Unearne
d
Revenue

9/14/2012 7:47:10
PM

I have a couple thoughts about those funds, 1st

depending on the time of the year I would consider
investing into new/updated equipment. Second
would be counting as revenue profit and dividing
with shareholders if it's a corporate. Third I would
have my CFO checking into investment
opportunities where we could generate more profit
over time or investing into long term ventures.
Finally I would consider investing into the
community to be a good steward of some non profit
initiative to generate a stronger foundation in the
surrounding area.

RE:
Prepaid
Expenses
vs.
Marie Roberts
Unearne
d
Revenue

9/14/2012 9:28:12
AM

I think that if I was a business owner or a

CEO of a business I would want to pay off

debt that I owed such as outstanding loans. I

would also try to buy assets that would
strengthen the company.
I think that a company might want to prepay
expenses if they were leasing a fleet of
vehicles and the interest rates were low. I
think also that if they were buying a building
and the interest rates were low this would be a
good idea to take advantage of the low
interest rates at that time and purchase the
building or prepay for lease space.

RE:
Prepaid
Expenses
Professor Thomas
vs.
Unearned
Revenue

9/15/2012 7:25:26
PM

This is a good point Marie. Generally,

when interest rates are low, you do not
want to have money sitting an account
earning interest because you are being paid
very little interest. (Consider earning
interest of 2% versus 5% ... if the amount
of interest you can earn is only 2%, you
would want to put the cash to other uses.)
Also, as you mention about debt ... it may
not make sense to prepay for expenses if
you have debt that is outstanding. Class,
think about your own financial
responsibility ... would you prepay you car
payment 3 months in advance if you have a
balance on your credit card?

RE:
Prepaid
Expenses
vs.
Diangelo Miller
Unearne
d
Revenue

9/15/2012 11:13:18
AM

Buy more equipment to create more revenue and I

also have a question with all the prepaid expenses

wouldn't that make the company more expensive to
purchase.

RE:
Prepaid
Expenses
Edward Steward
vs.
Unearned
Revenue

9/16/2012 7:14:16
PM

Your right Diangelo, I thought the same

thing, but I would think while making it
expensive it still would be less than having
the expense as your own.

Prepaid
Expenses
vs.
Unearned
Revenue

Dimitra Arrieta

9/12/2012 8:48:09 PM

Unearned revenues are also called deferred revenues and revenues collected in
advance. For all unearned revenue the business has received cash from customers
before earning the revenue. The company has a liability-an obligation to provide
goods or service to the customers (money owed).
Prepaid expense is a n expense paid in advance. Therefore, prepaid expenses are
assets because they provide a future benefit for the owner.
B) because the prepaid expense puts you in a position to inquire or look for other
investments too.

Prepaid
expenses vs.
Marvalyn Richards
Unearned
Revenue

9/12/2012 9:03:35 PM

I would decide on Glass Team since it has a larghe amount of Prepaid Expenses and no Unearned
Revenue. Reason is that Prepaid Expenses are considered assets since the service has not been
received as yet, and no Unearned Revenue means that no service is owing to anyone.

RE:
Prepaid
expenses
Professor Thomas
vs.
Unearned
Revenue

9/13/2012 8:31:51 AM

Hi Marvalyn,
What is it about large prepaid expenses that is more attractive than unearned
revenue?

RE:
Prepaid
expenses
Diangelo Miller
vs.
Unearned
Revenue

9/14/2012 12:34:27 PM

I guess because everybody feels since it goes to assets but prepaid

expenses does not say anything about how the business progress to
me and also I believe when purchasing the company it would be
more costly because of the prepaid expenses.

RE:
Prepaid
expenses
Marvalyn Richards
vs.
Unearned
Revenue

9/18/2012 8:41:56 PM

Hi Professor:
Large pre-paid expenses are assets, while un-earned revenue is money we
receive before performing a service, and it is considered a liability.

Prepaid
Expenses
vs.
Unearned
Revenue

Diangelo Miller

9/13/2012 4:37:06 PM

Prepaid Expenses is the prepaying of expenses before the expenses are used. I believe
unearned revenue is money given by the customer but has not used the service or
recieved the good. I would go with A because their unearned revenue would how good
their business is.

RE:
Prepaid
Expenses
Professor Thomas
vs.
Unearned
Revenue

9/16/2012 5:11:13 PM

Hi Diangelo,
Can you provide more details on how unearned revenue is an indication of the
how good a company is?

RE:
Prepaid
Expenses
vs.
Unearned
Revenue

Dimitra Arrieta

9/13/2012 10:16:06 PM

Modified:9/13/2012 10:18 PM
Prepayments
Prepayments are prepaid expenses and unearned revenues that have occurred in the
accounting period. One is classified as an asset the other a liability.
>Prepaid expenses
A prepaid expense is an expenditure that is already paid for and recorded as an asset. It
is owned by the organization, but hasn't yet been used.
An example of prepaid expenses is insurance policies. Money is paid upfront in
exchange for several months to a year of coverage. Since the dates the coverage
provides for has not occurred yet, this means the insurance policy theoretically hasn't
been used. As time passes on the policy, eventually it will deplete and will cease to
being an asset once the insurance policy's time frame for coverage expires.
>Unearned Revenues
Unearned revenues are monies that are received but the organization still has to
provide the service or deliver the product to complete their end of the transaction. This
is classified as a liability because there is still an obligation to be met even though
money has been collected.
An example of unearned revenue would be a company that takes prepayment for a
service. Say an oil company requires upfront payment in order to guarantee a

customer to lock in a lower price for winter fuel, and they purchase 1,000 gallons of
fuel. The customer has paid for both the oil and the delivery, but the fuel and delivery
has not yet taken place, thus it is unearned even though money has exchanged hands.
This kind of accounting event would be recorded in an accounted worded along the
lines of "unearned revenue" and each month a portion of it would flip over to earned
income after each delivery is made. For instance if the company makes a $300
delivery, than this amount would turn into earned income and be adjusted accordingly
at the end of each accounting period.
http://www.helium.com/items/1655327-understanding-adjusting-entries-in-accrualaccounting

RE:
Prepaid
Expenses
Quintavious Mapp
vs.
Unearned
Revenue

9/14/2012 7:53:27 PM

Very detailed explanation Dimitra! Which of the two glass manufacturs

would you choose?

RE:
Prepaid
Expenses
Dimitra Arrieta
vs.
Unearned
Revenue

9/14/2012 11:46:17 PM

I would choose B) Glass Team because the prepaid expense puts you
in a position to inquire or look for other investments too.

RE:
Prepaid
Expenses
Professor Thomas
vs.
Unearned
Revenue

9/16/2012 5:10:18 PM

Hi Dimitra,
Can you explain further? How does having prepaid
expenses allow the company to look for other investments?

RE:
Prepaid
Expenses
vs.
Dimitra Arrieta
Unearne
d
Revenue

9/18/2012 5:24:52
PM

Modified:9/18/2012 6:10 PM
By having prepaid expenses other income or capital
can be used for future investments.

RE:
Prepaid
Expenses
vs.
Unearned
Revenue

Quintavious Mapp

9/14/2012 7:44:33 PM

Modified:9/14/2012 7:44 PM
Unearned revenue is cash that is not recieved yet and prepaid expenses are expenses
paid ahead of time for a future benefit. I would acquire b. because I have a better lay
out to go from.

RE:
Prepaid
Expenses
Amirah Howard
vs.
Unearned
Revenue

9/16/2012 12:01:04 AM

I agree, I don't want a company that is not getting paid yet, because if they
don't pay we don't make our money.

RE:
Prepaid

Professor Thomas

9/16/2012 5:09:27 PM

Expenses
vs.
Unearned
Revenue
Hi,
What do you mean by "lay out"?

RE:
Prepaid
Expenses
Quintavious Mapp
vs.
Unearned
Revenue

9/16/2012 9:37:02 PM

Considering the expenses of a company before choosing to get it.

The data that I have from the company.

Prepaid
expenses vs
Edward Steward
Unearned
Revenue

9/16/2012 7:04:09 PM

Prepaid expenses are assests, they provide future benefits for the owner, they are
expenses paid in advance.
Unearned revenue creates a liability, collectin cash from services not yet performed.
I would think the Glass Team "B" would be the better of the two to acquire, only
because they have more assets, so you will be gaining more than with the other.

RE:
Prepaid
expenses
Amirah Howard
vs
Unearned
Revenue

9/17/2012 7:09:18 AM

I totally agree, I don't want to start a company that already has liabilities,
when choosing a company. Assets should always be a good sign a company is
doing good for itself.

RE:
Prepaid
expenses
Professor Thomas
vs
Unearned
Revenue

9/17/2012 7:34:32 AM

Hi Edward / Amirah (or class),

While it is true that unearned revenue creates a liability, would you
consider unearned revenue to be a liability ... in a traditional sense?
Meaning, when most people think of liabilities, they think of owing
cash to another party ... for example, accounts payable or notes
payable. (At a point in time in the future, you will need to pay cash
to someone.) Does unearned revenue reflect the same type of
liability?

RE:
Prepaid
expenses
Marvalyn Richards
vs
Unearned
Revenue

9/18/2012 9:06:15 PM

Professor, I have been thinking of that same aspect of unearned

revenue being a liability. Because, say for instance I have a pastry
making company, someone prepays me for making a cake, but I
have not made and delivered the cake as yet, all I need to do is make
the cake and deliver it, of course if I have to purchase the material to
make the cake, which would be an expense, but I am looking at it as
material that will be taken from my inventory, which means I am
spending no more money. It is even easier if I am operating a
cleaning service and the cleaning items are provided by the client,
all I would be offering is the service of cleaning with no other
expense. I remember you saying some information we just have to
memorize, and this case of unearned income being a liability seems
to be one of them. Just like how we credit each expense account and
debit retained earning, and by debiting retained earning it has been
decreased etc. Am I seeing this correctly Professor?

RE:
Prepaid
expenses
Marvalyn Richards
vs
Unearned
Revenue

9/19/2012 7:07:45 PM

Amirah, I want to agree with you but also it depends on the total
liabilities and the clientele that that company has. It may be a
case where the liabilities could be easily paid off especially if it
carries dedicated customers. I suppose the financial history of
that company would be important, as mismanagement could be
the reason for them being in debt.