CHAPTER 3

CURRENT LIABILITIES

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 [Link] nature of liabilities

▪ What is a Liability?

▪ IASB defines a liability as a present obligation of a company arising from past

events, the settlement of which is expected to result in an outflow from the company
of resources, embodying economic benefits.

❖ In other words, a liability has three essential characteristics:

1. It is a present obligation.

2. It arises from past events.

3. It results in an outflow of resources (cash, goods, services)

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 What is a Current Liability?

▪ Current liabilities are “short-term financial obligations that a company is

expected to pay within one year or within its normal operating cycle, whichever
is longer. These are usually settled using current assets like cash, accounts
receivable, or inventory.

▪ Current liabilities are

✓ debts a business must pay within a year.

✓ also called short-term liabilities are debts a company must pay within a normal
operating cycle, usually less than 12 months (as opposed to long-term liabilities,
which are payable beyond 12 months).

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 3.2. Classification of liabilities
1. Current Liabilities (or Short-Term Liabilities):
▪ These are obligations that a company expects to settle within one year or its
operating cycle, whichever is longer.
Examples: Accounts payable, payroll due, payroll taxes, accrued expenses, short-
term notes payable, income taxes, interest payable, accrued interest, utilities, rental
fees, and other short-term debts.
2. Non-Current Liabilities (or Long-Term Liabilities):
▪ These are obligations that are due beyond one year.
Examples: Mortgages, deferred revenues, bonds, warranties, and accrued expenses.
3. Contingent Liabilities:
▪ These are potential obligations that depend on a future event or circumstance.
▪ They are not recognized on the balance sheet unless the obligation is probable
and can be reasonably estimated.
Examples:
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Guarantees, lawsuits, and environmental
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clean-up costs. 4
 3.3. Types of current liabilities

Accounts payable. Customer advances and deposits.

Notes payable. Unearned revenues.
Current maturities of long-term debt. Sales taxes payable.
Short-term obligations expected to be refinanced. Income taxes payable.
Dividends payable. Employee-related liabilities.

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 1. Accounts Payable (Trade accounts payable)
▪ Balances owed to others for goods, supplies, or services purchased on open
account.(the amounts a business owes to suppliers for buying goods or services
on credit.)

• Arise because of time gap between receipt of goods or services and the payment for
them (The company gets the items first and pays later).
• The terms of the sale (e.g., 2/10, n/30) state period of extended credit.

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 2. 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.

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 Cont..
⚫ Interest-Bearing Note: it explicitly state an interest rate on the face of the note. So, at
maturity, the borrower pays the cash received and interest.

Illustration-1: Castle National Bank agrees to lend Birr 100,000 on March 1, 2021, to
Landscape Co. if Landscape signs a Birr 100,000, 6 percent, four-month note. Landscape
records the cash received on March 1 as follows:

Cash 100,000
Notes Payable 100,000

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 Cont..

Illustration-1: If Landscape 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

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 Cont..
Illustration: At maturity (July 1), Landscape records payment of the note and accrued
interest as follows.

Notes payable 100,000

Interest payable 2,000
Cash 102,000

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 Cont..
▪ Zero-Interest-Bearing Note: does not explicitly state an interest rate on the
face of the note.

▪ However, interest is still charged

▪ At maturity, the borrower must pay back an amount greater than the cash
received at the issuance date.

▪ In other words, the borrower receives in cash the present value of the note.

▪ The present value equals the face value of the note at maturity minus the
interest or discount charged by the lender for the term of the note.

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 Cont..
Illustration-2: On March 1, Landscape issues a Birr 102,000, four-month,
zero-interest-bearing note to Castle National Bank. The present value of the
note is Birr 100,000. Landscape records this transaction as follows.

Cash 100,000

Discount on notes payable 2,000

Notes payable 102,000

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

▪ current liabilities
Notes Payable-------------------------$102,000
Less ;discount on notes payable -----2,000 100,000

Landscape charges the discount to interest expense over the life of the note.

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 Cont.
Illustration-3: The following are selected 2010 transactions of KC Corporation.

Sept. 1 - Purchased inventory from Orion Company on account for Birr 50,000.
KC records purchases gross and uses a periodic inventory system.

Oct. 1 - Issued a Birr 50,000, 12-month, 8% note to Orion in payment of

account.

Oct. 1 - Borrowed Birr 75,000 from the Shore Bank by signing a 12-month,
zero-interest-bearing Birr 81,000 note.

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 Solution

▪ Sept. 1 - Purchased inventory from Orion Company on account for Birr

50,000. KC records purchases gross and uses a periodic inventory system.

Sept. 1 Purchases 50,000

Accounts payable 50,000

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 Solution

Oct. 1 - Issued a Birr 50,000, 12-month, 8% note to Orion in payment of account.

Interest calculation = (Birr 50,000 x 8% x 12/12) = $4,000

Oct. 1 Accounts payable 50,000

Notes payable 50,000

Dec. 31 Interest expense 4,000

Interest payable 4,000

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 Solution
Oct. 1 - Borrowed Birr 75,000 from the Shore Bank by signing a 12-month,
zero-interest-bearing Birr 81,000 note.

Oct. 1 Cash 75,000

Discount on notes payable 6,000
Notes payable 81,000

Interest calculation = (Birr 6,000 x 12/12) = Birr 6000

Dec. 31 Interest expense 6000

Discount on notes payable 6000
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 3. Current Maturities of Long-Term Debt:
▪ Long-term indebtedness that matures within the next fiscal year.

▪ Exclude long-term debts maturing currently as current liabilities if they are

to be:

1. Retired by assets accumulated that have not been shown as current assets,

2. Refinanced, or retired from the proceeds of a new long term debt issue, or

3. Converted into ordinary stock.

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 4. Short-term obligations expected to be refinanced:

▪ Means either replacing it with a long-term obligation or equity securities,

or renewing, extending, or replacing it with short-term obligations for an
uninterrupted period extending beyond one year (or the normal operating
cycle) from the date of the company’s statement of financial position.

▪ These short-term obligations will not require the use of working capital
during the next year.

▪ Such obligations excluded from current liabilities.

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 Cont.
▪ llustration-4 (Refinancing of Short-Term Debt): On December 31, 2010, Alexander
Company had Birr 1,200,000 of short-term debt in the form of notes payable due
February 2, 2011. On January 21, 2011, the company issued 25,000 shares of its
common stock for Birr 36 per share, receiving Birr 900,000 proceeds after
brokerage fees and other costs of issuance. On February 2, 2011, the proceeds
from the stock sale, supplemented by an additional Birr 300,000 cash, are used to
liquidate the Birr 1,200,000 debt. The December 31, 2010, balance sheet is issued
on February 23, 2011.

▪ Instructions

▪ Show how the Birr 1,200,000 of short-term debt should be presented on the
December 31, 2010, balance sheet, including note disclosure
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 Solution

Partial Balance Sheet

Current liabilities:
Notes payable-------------------------- Birr 300,000
Long-term debt:
Notes payable refinanced ------------------ 900,000

Total liabilities--------------------------------- Birr 1,200,000

LO 2 Explain the classification issues of short-term debt expected to be

refinanced.

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 [Link] Payable
▪ Amount owed by a corporation to its stockholders as a result of board of
directors’ authorization.

✓Generally paid within three months.

✓Undeclared dividends on cumulative preferred stock not recognized as a

liability.

✓Dividends payable in the form of shares of stock are not recognized as a

liability. Reported in equity.

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 [Link] Advances and Deposits
▪ Include returnable cash deposits received from customers and employees.

✓ May be classified as current or long-term.

▪ These are payments received from customers before the company delivers goods or services.

▪ They are considered a liability because the company still owes the product or service.

▪ Once the goods or services are delivered, the liability is removed and revenue is recognized.

Examples:

➢ A customer pays in advance for a custom order.

➢ A deposit for a future hotel booking or event.

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 [Link] Revenues
▪ Payment received before delivering goods or rendering services
▪ Unearned and Earned Revenue Accounts

Type of Business Unearned Revenue Earned Revenue

Airline Unearned Passenger Ticket Revenue Passenger
Magazine publisher Unearned Subscription Revenue Revenue
Hotel Unearned Rental Revenue Subscription Re
Auto dealer Unearned Warranty Revenue Rental Revenue
Retailers Unearned Gift Card Revenue Warranty Revenue
Sales Revenue

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 Cont.

▪ llustration-5: Sports Pro Magazine sold 12,000 annual subscriptions on

August 1, 2010, for Birr 18 each. Prepare Sports Pro’s August 1, 2010,
journal entry and the December 31, 2010, annual adjusting entry.

Aug. 1 Cash 216,000

Unearned revenue 216,000
(12,000 x Birr 18)

Dec. 31 Unearned revenue 90,000

Subscription revenue 90,000
(Birr 216,000 x 5/12 = Birr 90,000)
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 [Link] Taxes Payable

▪ Retailers must collect sales taxes from customers on transfers of tangible

personal property and on certain services and then remit to the proper
governmental authority.

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 Cont.
• llustration-6: Dillons Corporation made credit sales of Birr 30,000 which are subject to 6%
sales tax. The corporation also made cash sales which totaled Birr 20,670 including the 6%
sales tax. (a) prepare the entry to record Dillons’ credit sales. (b) Prepare the entry to
record Dillons’ cash sales.
Accounts receivable ------------------ 31,800
Sales------------------------------------------- 30,000
Sales tax payable--------------------------- 1,800
(Birr 30,000 x 6% = Birr 1,800)

Cash ------------------------------------ 20,670

Sales------------------------------------------- 19,500
Sales tax payable--------------------------- 1,170
(Birr 20,670  1.06 = Birr 19,500)
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 [Link] Tax Payable
❑ Businesses must prepare an income tax return and compute the income
tax payable resulting from the operations of the current period.

➢Taxes payable are a current liability

➢Corporations must make periodic tax payments throughout the year.

➢Differences between taxable income and accounting income sometimes

occur.

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 [Link]-Related Liabilities

❖Amounts owed to employees for salaries or wages are reported as a

current liability.

▪ In addition, current liabilities may include:

➢Payroll deductions.

➢Compensated absences.

➢Bonuses.

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 [Link] Deductions
❑Taxes:
➢Social Security Taxes
➢Unemployment Taxes
➢Income Tax Withholding

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 [Link] Absences
▪ Paid absences for vacation, illness, and holidays.
❖Accrue a liability if all the following conditions exist.
➢The employer’s obligation is attributable to employees’ services already
rendered.
➢The obligation relates to rights that vest or accumulate.
➢Payment of the compensation is probable.
➢The amount can be reasonably estimated.

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 13. Bonus Agreements

❑Result in payments to certain or all employees in addition to their regular

salaries or wages.

➢Bonuses paid are an operating expense.

➢Unpaid bonuses should be reported as a current liability.

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 3.5. Presentation of current liabilities on the balance sheet
▪ Usually reported at their full maturity value.

▪ Difference between present value and the maturity value is considered

immaterial.

Provision - Potential liability that may become an actual liability in the future.

❑Three levels of probability:

• Probable

• Reasonably possible

• Remote

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 Reporting Current Liabilities
Croix Beverages
Statement of Financial Position
December 31, 2020 (partial, in thousands)

Current liabilities
Notes payable---------------------------------------------------- € 4,157
Accounts payable------------------------------------------------- 3,990
Accrued expenses------------------------------------------------- 1,847
Salaries and wages payable------------------------------------ 1,730
Unearned revenues ----------------------------------------------555
Income taxes payable -------------------------------------------259
Warranty liability------------------------------------------------ 141
Long-term debt due within one year -----------------------3,531
Total current liabilities------------------------------------------ €16,21

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 DO IT! 2: Reporting

Tron Cellular has the following account balances at December 31, 2020.
Notes payable (NT$80,000 due after 12/31/21) NT$200,000
Unearned service revenue 75,000
Other long-term debt NT$30,000 due in 2021
Salaries and wages payable 22,000
Other accrued expenses 15,000
Accounts payable 100,000
In addition, Tron is involved in a lawsuit. Legal counsel feels it is probable
Tron will pay damages of NT$38,000 in [Link] the current
liabilities section of Tron’s December 31, 2020, statement of financial
position.

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 DO IT! 2: Reporting
Prepare the current liabilities section of Tron's December 31, 2020, statement of financial
position
Current liabilities
Notes payable (NT$200,000 − NT$80,000) ----------------------NT$120,000
Accounts payable -------------------------------------------------------100,000
Unearned service revenue --------------------------------------------75,000
Lawsuit liability---------------------------------------------------------- 38,000
Long-term debt due within one year------------------------------- 30,000
Salaries and wages payable -------------------------------------------22,000
Other accrued expenses -----------------------------------------------15,000
Total current liabilities -----------------------------------------------NT$400,000

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 •End of Chapter

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