ABC Inc. has just entered into the business of selling antique cars. The company management decided to lease the premises for the business instead of buying the office premises. They ended up paying an advance rent of $5 million dollars for the initial period of five years. The entire amount was recorded as an asset in the form of prepaid expense. When questioned by the auditors, the CFO of ABC Inc. mentioned, 'An asset is just an expense waiting to happen'. Discuss the validity and implications of this statement.
STUDENT VIEWPOINT # 1
Any time you make a payment for an expense which covers more than one year you must treat that portion of the amount which is more than 12 months as a prepaid expense and carry it on your balance sheet as a prepaid expense. In this case $4 million would be carried as prepaid expense and written off over the next 4 years. Assets are depreciated. In this case, the $5 million will be depreciated over 60 months. This is technically leasehold, which is a prepaid expense. The company never owns the building, so when the lease period is over the company will have to move or renegotiate a new lease. The company never gains title to the building. Therefore the company can't sell the building and possibly recoup some of its cost. Hence, the comment from GFO of ABC Inc. "An asset is just an expense waiting to happen."
STUDENT VIEWPOINT # 2
While this is technically a true statement, this expense should not be counted as an asset because it is a transaction that has been paid to another company; it is a prepaid account that will distributed over a period 5 years (60 months). If the amount was to be distributed for property that is being bought then I could see how this expense could be considered an asset.
'An asset is just an expense waiting to happen' is a valid statement in a broad way of thinking. The assets of a company are there to be used a way to show value that the company has; assets can be allocated to be able to be turned into money if needed. However, in the case when the money is already allocated to a specific account/expense then it is considered a transaction. In this example it is a prepaid transaction. QUESTION: How would you record the journal entry for this transaction? What happens as the lease expires?
The comment about an asset is an expense is true in most cases. There are various assets that will never become expenses. I would say a more accurate statement would be, "a prepaid asset is an expense waiting to happen." You're correct; the building never becomes an asset. The company never has any rights to the building. They cannot sell or depreciate the building. After the lease term expires, the company has nothing left, they either need to sign a new lease or figure out where to go. As the prepaid expense gets expensed each month (or year), the value of prepaid rent decreases, and at the end of the term (5 years) becomes zero. Nothing has been gained.
No - a prepaid expense is definitely an asset, regardless of ...
The solution provides a good discussion on the comment, "an asset is just an expense waiting to happen."