CHAPTER THREE

CURRENT LIABILITY
Objective of the study
After studying this chapter, you should be able to describe:
 The Nature of liability
 Classification of liabilities
 Types of current liabilities
 Short-term notes payable
 Presentation of current liabilities on the balance sheet

3.1. The Nature of liability

Liabilities classified as current and long-term liabilities. Current liabilities are liabilities that will mature (due)
in less than one year or one operating cycle, whichever is shorter. Long-term liabilities are liabilities that will
mature (due) in greater than one year or one operating cycle, whichever is longer. Hence there are various types
of liabilities such as: Account Payable, Short Term Notes Payable, Accrued Liabilities, Unearned Revenue and
so on. Accounts Payable: accounts payable is oral promises to others to pay for goods or services purchased on
open account.
Illustration: A corporation purchased inventory on open account at an invoice price of $5,000; terms were
2/10, n/30.
Purchases ………………………………………………… 5,000

Accounts Payable ……………………………………………...5,000

The corporation paid the invoice within the discount period

Account payable ……………………………………………… 5000

Cash ………………………………………………………………...4,900
Purchase discount ………………………………………………….....100
Sales Tax Payable: business collect sales tax in addition to the price of the item sold. Thus, the business must
pay the government in less than a year.
Illustration: ABC company sold2 TV at a unit price of $1,000 plus 15%VAT in cash

Cash ………………………………………………… 2,300

Sales …………………………………………………......2000
VAT Payable ………………………………………….......300

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 At the end of the month, ABC Company remitted the collected VAT to the government.

VAT payable …………………………………300

Cash ………………………………………………...300

Current Portion of Long-term Notes Payable: most long-term notes payables are paid in installments. The
current portion of notes payable (also called current maturity) is the principal amount that will be paid within
one year.

Illustration: ABC Company borrowed $20,000 on May1, 2015

Cash ………………………………………………….20, 000

Long-Term Notes Payable ………………………………….20, 000

If the notes will be paid over four years with repayment of $5000 on May 1 of each four years. The following
entry required to reclassify some of the long term notes payable in to the short term notes payable.

Long-Term Notes Payable 5000

Short-Term Notes Payable 5000

Unearned Revenues: - amounts that are received before goods are delivered or services are rendered are
recognized as a current liability until the goods are delivered or the services are rendered.

Illustration: ABC Company rents the portion of its building for about ten months. Hence the company
received $6000 for the next ten months.
Cash ………………………………………………... 6000

Unearned Revenue ………………………………………6000

Accrued Liabilities: accrued expenses are any expenses that has been incurred but not yet paid in cash. When
expenses are accrued (debited), it often has a related unpaid amount (accrued liabilities (credited)).
Illustration: ABC Company used the services of its employees for the month of June, 2015 but not paid their
salaries of $10,000

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 Salary Expense …………………………………. 10000

Salary Payable ……………………………………. 10000

3.2. Classification of liabilities
Liability is classified as current if a condition is breached at or before the reporting date and a waiver is
obtained after the reporting date. A loan is classified as non-current if a covenant is breached after the reporting
date entity's own equity instruments. Current liabilities are due within a year and are often paid for using
current assets. Non-current liabilities are due in more than one year and most often include debt repayments
and deferred payments. Current Liabilities: are the obligations due for payment or settlement within the next 12
months. Non - Current Liabilities: are long term obligations, including debts of the business, which are not due
for payment within the next financial year.

3.3. Types of current liabilities

Some examples of current liabilities that appear on the balance sheet include 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.

3.4. Short-term notes payable

Short-term notes payable (often simply referred to as “notes payable” when the context is clear) are promissory
notes that represent amounts a company or individual has borrowed and must repay within one year or within
the company's operating cycle, whichever is longer. They are a type of short-term liability. If your company
borrows money under a note payable, debit your Cash account for the amount of cash received and credit your
Notes Payable account for the liability. When you repay the loan, you'll debit your Notes Payable account and
credit your Cash account.

Notes payable is a liability account that’s part of the general ledger. Businesses use this account in their books
to record their written promises to repay lenders. Likewise, lenders record the business’s written promise to pay
back funds in their notes receivable. Once you create a note payable and record the details, you must record the
loan as a note payable on your balance sheet (which we’ll discuss later). In your notes payable account, the
record typically specifies the principal amount, due date, and interest. Notes payable can either be short-term
or long-term, depending on the timing. Short-term notes payable is due within 12 months. Long-term notes
payable is due after a year. Now that you know about notes payable, let’s get into how to record them in your
books. When you record notes payable on balance sheet, use the following accounts:

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  Cash

 Interest expense

 Interest payable

 Notes payable

If your company borrows money under a note payable, debit your Cash account for the amount of cash
received and credit your Notes Payable account for the liability. When you repay the loan, debit your Notes
Payable account and credit your Cash account. For the interest that accrues, you’ll also need to record the
amount in your Interest Expense and Interest Payable accounts. When your business borrows money from a
lender under a note payable, debit your Cash account and credit your Notes Payable account for the borrowed
amount:

Date Account Debit Credit

XX/XX/XXXX Cash X

Notes Payable X

To record the accrued interest, debit your Interest Expense account and credit your Interest Payable account for
the amount of interest. It should look like this in your books:

Date Account Debit Credit

XX/XX/XXXX Interest Expense X

Interest Payable X

When your business pays the interest expense, record the following:

Date Account Debit Credit

XX/XX/XXXX Interest Payable X

Cash X
When your company pays the loan back to the lender, debit your Notes Payable account and credit your Cash
account:

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 Date Account Debit Credit

XX/XX/XXXX Notes Payable X

Cash X

Notes payable examples

Example 1

Say your business borrows $15,000 from a lender. You create the note payable and agree to make payments
each month along with $100 interest.

Here’s what your balance sheet will look like:

Date Account Debit Credit

XX/XX/XXXX Cash $15,000

Notes Payable $15,000

Then, record the interest in your books like this:

Date Account Debit Credit

XX/XX/XXXX Interest Payable $100

Cash $100

Recording these entries in your books helps ensure your books are balanced until you pay off the liability.

Example 2

Your business took out a $10,000 loan from the bank. You’ve already made your original entries and
are ready to pay the loan back. Here’s what your entry will look like when you pay back the loan to
your lender:

Date Account Debit Credit

XX/XX/XXXX Notes Payable $10,000

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Date Account Debit Credit

Cash $10,000

Debit your Notes Payable account and debit your Cash account to show a decrease for paying back the
loan.

3.5. Presentation of current liabilities on the balance sheet

Current liabilities are listed on a company's balance sheet below its current assets and are calculated as a sum
of different accounting heads. Examples of typical items reported as current liabilities on a company's
balance sheet are: Accounts Payable: The amount owed to vendors and suppliers based on their invoices.
Some examples of current liabilities that appear on the balance sheet include 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. The order in which the current liabilities will appear on the
balance sheet can vary. However, it is common to see three (listed in any order) at the top of the
list: accounts payable, short-term loans payable, and the current portion of long-term debt.

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