Matilla, Sameh Jewel M. | BABA1F | ACCT201A_F
3.3.2.5 Elaborate 3.2 – Ceramics Company
Ceramics Company is a domestic company in the Philippines. It is in the production of ceramic
household products. In the analysis of Accounts Payable account, the Accountant observed that there
was an item outstanding for the last fourteen months. Further she noticed that this was much longer
than the average payment period being practiced by the company. She was confused whether to classify
the item as current or non-current liability. The Controller of the company has worked out the
following:
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Average raw material holding period is four months.
Average production period is three months.
Average finished goods inventory holding is five months.
Average collection period is six months.
Average payment period to creditors is two months.
The Accountant was wondering whether to apply Average Payment Period to creditors (six months) as
normal operating cycle for creditors and accordingly to classify the items as non-current as it was due
for more than twelve months (applying even a default operating cycle of twelve months).
Required: Advise the Accountant as to what she should do with the item being questioned in the case?
According to IAS 1, paragraph 69, current liabilities are those that are: (a) expected to be settled
within the entity’s normal operating cycle, (b) held for purpose of trading, (c) due to be settled within 12
months, and (d) for which the entity does not have the right at the end of the reporting period to defer
settlement beyond 12 months. All liabilities not classified as current are classified as non-current. For
this reason, the Accountant should classify the accounts payable account that has been outstanding for
fourteen months as a non-current liability.
Accordingly, I think it is only appropriate for the Accountant to apply Average Payment Period to
creditors (six months) as normal operating cycle for creditors. Payment period is a sensor for how
efficiently a company utilizes credit options available to cover short-term needs. The previous average
payment period to creditors of Ceramics Company is only two months. This shorter payment period
indicates prompt payments to creditors. A very short payment period may be an indication that the
company is not taking full advantage of the credit terms allowed by suppliers. Moreover, the average
collection period of the company is six months. This can mean that the company is having trouble
collecting its accounts, and it could also indicate trouble with cash flows.
Ceramics Company takes more time to collect accounts. Paying creditors abruptly may result to
financial distress. This may also be the reason why an accounts payable account in the company has
been outstanding for fourteen months already.