CURRENT LIABILITIES

CHAPTER :THREE
 3.1 The nature of Liabilities

FASB, defines liabilities as:

“Probable Future Sacrifices of Economic

Benefits arising from present obligations of a
particular entity to transfer assets or provide
services to other entities in the future as a
result of past transactions or events.”
 Current liabilities are “obligations whose liquidation is
reasonably expected to require use of existing resources
properly classified as current assets, or the creation of
other current liabilities.”
 A debt that a company expects to pay
1. from existing current assets or through the creation of
other current liabilities, and
2. within one year or the operating cycle, whichever is
longer.
 3.2. Classification of Liabilities

 Liabilities are classified as long term liability and

short term liability. Long-term liabilities are debt
due beyond one year.
 Current liabilities are debt that will be paid out of

current assets and are due within one year.

3.3. Types of Current Liabilities

The following are the types of current liabilities:

A. Account Payable
Also known as trade accounts payable, are balances owed
to others for goods, supplies, or services purchased on open
account.
Accounts payable arise because of the time lag between the
receipt of services or acquisition of title to assets and the
payment for them.
The terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.)
usually state this period of extended credit, commonly 30 to
60 days.
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B. Current Maturities of Long-term Debt

Companies report as part of its current liabilities the
portion of bonds, mortgage notes, and other long-term
indebtedness that matures within the next fiscal year.
It categorizes this amount as current maturities of long-
term debt.
A company should classify as current any liability that is
due on demand (callable by the creditor) or will be due
on demand within one year (or operating cycle, if
longer).
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C. Dividends Payable
A cash dividend payable is an amount owed by a
corporation to its shareholders as a result of board of
directors’ authorization (or in other cases, vote of
shareholders). At the date of declaration, the corp. assumes a
liability that places the shareholders in the position of
creditors in the amount of dividends declared.
Because companies always pay cash dividends within one
year of declaration (generally within three months), they
classify them as current liabilities.
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D. Customers Advances and Deposits

Current liabilities may include returnable cash deposits
received from customers and employees. Companies may
receive deposits from customers to guarantee performance
of a contract or service or as guarantees to cover payment
of expected future obligations.
E. Unearned Revenues
A magazine publisher receives payment when a customer
subscribes to its magazines. An airline company sells
tickets for future flights.
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To illustrate, assume that Logo University sells 10,000 season soccer

tickets at $50 each for its five-game home schedule. Logo University
records the sales of season tickets as follows.
August 6 Cash 500,000
Unearned Sales Revenue 500,000
(To record sales of 10,000 season tickets)

After each game, Logo University makes the following entry

Sept. 7 Unearned Sales Revenue 100,000
Sales Revenue 100,000
(To record sales of 10,000 season tickets)
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F. Sales and Value-Added Taxes Payable

Most countries have a consumption tax. Consumption taxes are generally
either a sales tax or a value-added tax (VAT).
Sales Taxes Payable
To illustrate the accounting for sales taxes, assume that Halo Supermarket
sells loaves of bread to consumers on a given day for €2,400. Assuming a
sales tax rate of 10 percent, Halo Supermarket makes the following entry
to record the sale.
Cash…………………………….. 2,640
Sales Revenue……………………...2,400
Sales Taxes Payable…………………240
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Value-Added Tax Payable

This tax is placed on a product or service whenever value is added at
a stage of production and at final sale.
Assume the following examples
1. Hill Farms Wheat Company grows wheat and sells it to Sunshine
Baking for $1,000. Hill Farms Wheat makes the following entry to
record the sale, assuming the VAT is 10 percent.
Cash ……………………………1,100
Sales Revenue…………………...1,000
Value-Added Taxes Payable……... 100
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2. Sunshine Baking makes loaves of bread from this wheat and sells
it to Halo Supermarket for $2,000. Sunshine Baking makes the
following entry to record the sale, assuming the VAT is 10 percent.
Cash 2,200
Sales Revenue 2,000
Value-Added Tax Payable 200

Sunshine Baking then remits to the government not $200 because

Sunshine Baking has already paid $100 to Hill Farms Wheat.
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3. Halo Supermarket sells the loaves of bread to consumers

for $2,400. Halo Supermarket makes the following entry to
record the sale, assuming the VAT is 10 percent.
Cash 2,640
Sales Revenue 2,400
Value-Added Tax Payable 240
Halo Supermarket then sends only $40 to the tax authority
as it deducts the $200 VAT already paid to Sunshine
Baking.
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G. Income Tax Payable

Corporations should classify as a current liability the taxes payable on

net income, as computed per the tax return. Unlike a corporation,
proprietorships and partnerships are not taxable entities.

I. Employee-Related Liabilities

Companies also report as a current liability amounts owed to employees

for salaries or wages at the end of an accounting period. In addition, they
often also report as current liabilities the following items related to
employee compensation.
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1. Payroll deductions
2. Compensated absences
3. Bonuses
Payroll Deductions: The most common types of payroll
deductions are taxes, insurance premiums, employee savings,
and union dues.
Social Security Taxes: Most governments provide a level of
social benefits (for retirement, unemployment, income,
disability, and medical benefits) to individuals and families.
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Funds for these payments generally come from taxes levied on both
the employer and the employee. Employers collect the employee’s
share of this tax by deducting it from the employee’s gross pay, and
remit it to the government along with their share.

Income Tax Withholding: Income tax laws generally require

employers to withhold from each employee’s pay the applicable
income tax due on those wages.
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Payroll Deduction Example: Assume a weekly payroll of $10,000
entirely subject to Social Security taxes (8%), with income tax
withholding of $1,320 and union dues of $88 deducted. The company
records the wages and salaries paid and the employee payroll
deductions as follows.
Salaries and Wages Expense 10,000
Withholding Tax Payable 1,320
Social Security Tax Payable 800
Union Dues Payable 88
Cash 7,792
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It records the employer payroll taxes as follows.

Payroll Tax Expense 800
Social Security Tax Payable 800

The employer must remit to the government its share of Social

Security tax along with the amount of Social Security tax deducted
from each employee’s gross compensation.
 3.4 Short term notes payable
19

Notes Payable
 Written promises to pay a certain sum of money on a specified future
date.
 Arise from purchases, financing, or other transactions.
 Notes classified as short-term or long-term.
 Notes may be interest-bearing or zero-interest-bearing.

Illustration (Interest-Bearing Note): AB Bank agrees to lend $100,000

on March 1, 2010, to XY Co. if XY signs a $100,000, 6 percent, four-
month note. XY records the cash received on March 1
 3.4 Short term notes payable
20

Illustration (Interest-Bearing Note): If XY prepares

financial statements semiannually, it makes the following
adjusting entry to recognize interest expense and interest
payable at June 30:
Interest calculation =($100,000 x 6% x 4/12) = $2,000
Interest expense 2,000
Interest payable
2,000
 3.4 Short term notes payable
21

Illustration (Interest-Bearing Note): At

maturity (July 1), XY records payment of the
note and accrued interest as follows.
Notes payable 100,000
Interest payable 2,000
Cash 102,000
 3.4 Short term notes payable
22

Illustration (Zero-Interest-Bearing Note): On

March 1, XY issues a $102,000, four-month,
zero-interest-bearing note to AB Bank. The
present value of the note is $100,000. XY
records this transaction as follows.
Cash 100,000
Discount on notes payable 2,000
Notes payable 102,000
 3.4 Short term notes payable
23

Illustration (Zero-Interest-Bearing Note):

The Discount on Notes Payable is a contra
account to Notes Payable.

XY charges the discount to interest

expense over the life of the note.
 3.4 Short term notes
24
payable
(Accounts and Notes Payable) The following
are selected 2010 transactions of KC Corporation.
Sept. 1 - Purchased inventory from Orion
Company on account for $50,000. KC records
purchases gross and uses a periodic inventory
system.
Oct. 1 - Issued a $50,000, 12-month, 8% note to
Orion in payment of account.
Oct. 1 - Borrowed $75,000 from the Shore Bank
by signing a 12-month, zero-interest-bearing
$81,000 note.
 3.4 Short term notes
25
payable
Sept. 1 - Purchased inventory from Orion Company on
account for $50,000. KC records purchases gross and uses
a periodic inventory system.
Sept. 1 Purchases 50,000
Accounts payable 50,000
Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion
in payment of account.
Interest calculation =($50,000 x 8% x 3/12) = $1,000
Oct. 1 Accounts payable 50,000
Notes payable 50,000

Dec. 31 Interest expense 1,000

Interest payable 1,000
 3.4 Short term notes
26
payable
Oct. 1 - Borrowed $75,000 from the Shore Bank by
signing a 12-month, zero-interest-bearing $81,000
note.
Oct. 1 Cash 75,000
Discount on notes payable 6,000
Notes payable 81,000
Interest calculation =($6,000 x 3/12) = $1,500

Dec. 31 Interest expense 1,500

Discount on notes payable
1,500
 3.5. Presentation of Current Liabilities
on the Balance Sheet
27

In practice, current liabilities are usually recorded and reported

in financial statements at their full maturity value.

Because of the short time periods involved, frequently less than

one year, the difference between the present value of a current
liability and the maturity value is usually not large. The
profession accepts as immaterial any slight overstatement of
liabilities that results from carrying current liabilities at maturity
value.
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Within the current liabilities section, companies may list

the accounts in order of maturity, in descending order of
amount, or in order of liquidation preference.
END OF CHAPTER THREE