CHAPTER -3-

Current liabilities
Nature of liabilities
• Liabilities as creditors’ claims on total assets and as existing
debts and obligations.
• These claims, debts, and obligations must be settled or paid at
some time in the future by the transfer of assets or services.
• The future date on which they are due or payable (maturity
date) is a significant feature of liabilities.
Classification of Liabilities
• Liabilities are categorized into two types:
– Long-term liabilities, also known as non-current liabilities;
– Short-term liabilities, also known as current liabilities; and
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• A current liability is a debt that the company expects to pay
within one year or the operating cycle, whichever is longer.
• Most companies pay current liabilities within one year by using
current assets rather than by creating other liabilities.
• Companies must carefully monitor the relationship of current
liabilities to current assets.
• This relationship is critical in evaluating a company’s short-
term debt paying ability.

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Types of current liabilities
• Current liabilities include
– Notes payable
– Accounts payable, and
– unearned revenues.
• They also include accrued liabilities such as taxes, salaries and
wages, and interest payable

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Notes Payable
• Companies record obligations in the form of written notes as
notes payable.
• Notes payable are often used instead of accounts payable
because they give the lender formal proof of the obligation in
case legal remedies are needed to collect the debt.
• Companies frequently issue notes payable to meet short-term
financing needs. Notes payable usually require the borrower
to pay interest. Notes are issued for varying periods of time.
• Those due for payment within one year of the statement of
financial position date are usually classified as current
liabilities.
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• To illustrate the accounting for notes payable, assume that
Hong Kong National Bank agrees to lend $100,000 on
September 1, 2014, if C. W. Co. signs a $100,000, 12%, four-
month note maturing on January 1.
• When a company issues an interest-bearing note, the amount
of assets it receives upon issuance of the note generally equals
the note’s face value. C. W. Co. therefore will receive
$100,000 cash and will make the following journal entry.
Sept. 1 Cash ----------------- 100,000
Notes Payable ------------ 100,000
(To record issuance of 12%, 4-month note to Hong Kong National Bank)

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• Interest accrues over the life of the note, and the company
must periodically record that accrual. If C. W. Co. prepares
financial statements annually, it makes an adjusting entry at
December 31 to recognize interest expense and interest
payable of $4,000 ($100,000 x 12% x 4/12).
• C. W. Co. makes an adjusting entry as follows.
Dec. 31 Interest Expense ---------- 4,000
Interest Payable ----------- 4,000
(To accrue interest for 4 months on Hong Kong National Bank note)

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• Upon maturity the C. W. Co. must pay the face value of the note
($100,000) plus $4,000 interest ($100,000 x 12% x 4/12). It records
payment of the note and accrued interest as follows.
Jan. 1 Notes Payable --------------- 100,000
Interest Payable ------------- 4,000
Cash ---------------------------- 104,000
(To record payment of Hong Kong National Bank interest-bearing note
and accrued interest at maturity)

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• Sales Taxes Payable (VAT Payable in Ethiopia)
• As a consumer, you know that many of the products you
purchase at retail stores are subject to sales taxes (VAT).
• Sales taxes are expressed as a percentage of the sales price.
• The selling company collects the tax from the customer when the
sale occurs.
• Periodically, the retailer remits the collections to the
government’s department of revenue.
• Under most government sales tax laws, the selling company must
enter separately on the cash register the amount of the sale and
the amount of the sales tax collected.
• The company then uses the cash register readings to credit Sales
Revenue and Sales Taxes Payable. 9
• For example, if the cash register reading for ABC shows sales of Birr
100,000 and sales taxes of Birr 15,000 (VAT rate of 15%), the journal
entry is:
Mar. 25 Cash ----------------- 115,000
Sales Revenue ------------ 100,000
VAT Payable -------------- 15,000
(To record sales and sales taxes)
• When the company remits the taxes to the taxing agency, it debits VAT
Payable and credits Cash.
VAT payable ----------------- 15,000
Cash ---------------------- 15,000
• The company does not report sales taxes as an expense.
• It simply forwards to the government the amount paid by the customers.
Thus, serves only as a collection agent for the taxing authority. 10
Unearned Revenues
• An airline company, often receives cash when it sells tickets for future
flights.
• How do companies account for unearned revenues that are received
before goods are delivered or services are provided?
1. When a company receives the advance payment, it debits Cash and
credits a current liability account identifying the source of the unearned
revenue.
2. When the company recognizes revenue, it debits an unearned revenue
account and credits a revenue account.

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• To illustrate, assume that the a stadium sells 10,000 season
football tickets at Birr 50,000 each for its five-game home
schedule. The club makes the following entry for the sale of
season tickets.
Aug. 6 Cash -------------- 500,000
Unearned Ticket Revenue------500,000
(To record sale of 10,000 season tickets)
• As each game is completed, it records the recognition of
revenue with the following entry
Sept. 7 Unearned Ticket Revenue ------ 100,000
Ticket Revenue -------------------100,000
(To record football ticket revenue) 12
Current Maturities of Long-Term Debt
• Companies often have a portion of long-term debt that comes
due in the current year.
• That amount is considered a current liability.
• Companies often identify current maturities of long-term debt
on the statement of financial position as long-term debt due
within one year.
• It is not necessary to prepare an adjusting entry to recognize
the current maturity of long-term debt.
• At the statement of financial position date, all obligations due
within one year are classified as current, and all other
obligations as non-current. 13
 Presentation of current liabilities on the balance sheet
• Current liabilities are presented after non-current liabilities on the
statement of financial position.
• Each of the principal types of current liabilities is listed separately.
• In addition, companies disclose the terms of notes payable and other key
information about the individual items in the notes to the F/S.
• Companies seldom list current liabilities in the order of liquidity. The
reason is that varying maturity dates may exist for specific obligations such
as notes payable.
• A more common method of presenting current liabilities is to list them by
order of magnitude, with the largest ones first. Or, as a matter of custom,
many companies show notes payable first and then accounts payable,
regardless of amount.
• Then, the remaining current liabilities are listed by magnitude.
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 END OF
CHAPTER 3
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