Current Liabilities | Boundless Accounting | (2024)

Defining Current Liabilities

Current liabilities are usually settled with cash or other assets within a fiscal year or operating cycle, whichever period is longer.

Definition of a Liability

In financial accounting, a liability is defined as an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of future economic benefits. Liabilities are reported on the balance sheet, along with assets and owner's equity. They are an important part of the basic accounting equation -- assets = liabilities + owner's equity. A liability is defined by one of the following characteristics:

1. A borrowing of funds from individuals or banks for improving a business or personal income that is payable during a short or long time period.
2. A duty or responsibility to others that entails settlement by future transfer or use of assets, provision of services, or other transaction yielding an economic benefit, at a specified date, on occurrence of a specified event, or on demand.
3. A duty or responsibility that obligates the entity to another entity, with no option to avoid settlement.
4. A transaction or event that has already occurred and obligates the entity.

Definition of a Current Liability

A current liability can be defined in one of two ways: (1) all liabilities of the business that are to be settled in cash within a firm's fiscal year or operating cycle, whichever period is longer or (2) all liabilities of the business that are to be settled by current assets or by the creation of new current liabilities. Another important point is that current liabilities are many times not "current" and are actually past due. For example, accounts payable are due within 30 days and are typically paid within 30 days. However, they do often run past 30 days or 60 days in some situations. So, the accounts payable balance reported on the balance sheet under "current" liabilities may include amounts that are over 30 days due.

Accounts Payable

Accounts payable is money owed by a business to its suppliers and creditors and typically shown on its balance sheet as a current liability.

Definition of Accounts Payable

Accounts payable (A/P) is money owed by a business to its suppliers and creditors. It is typically shown on its balance sheet as a current liability. In addition to its disclosure on the balance sheet, accounts payable is recorded in the A/P sub-ledger at the time an invoice is vouchered for payment. Vouchered, or vouched, means that an invoice is approved for payment and has been recorded in the general ledger or A/P sub-ledger as an outstanding, or open, liability because it has not been paid. Payables are often categorized as trade payables, or purchases of physical goods that are recorded in inventory. Another category is expense payables, or purchases of goods or services that are expensed. Common examples of expense payables are advertising, travel, entertainment, office supplies, and utilities. A/P is a form of credit that suppliers offer to their customers by allowing them to pay for a product or service after it has been received. Suppliers offer various payment terms for an invoice.

Processing Accounts Payable

A/P payment terms may include the offer of a cash discount for paying an invoice within a defined number of days. For example, the 2/10 Net 30 term means that the seller will deduct 2% from the invoice total if payment is made within 10 days and the invoice must be paid within 30 days. If the payment is delayed until Day 31 then the full amount of the invoice is due and past due charges may apply. As invoices are paid, the amounts are recorded as reductions to the accounts payable balance in the liability section and cash in the assets section of the balance sheet. The A/P payment process begins as an invoice is received by the purchaser and matched to a packing (receiving) slip and purchase order. When the three documents are matched, the invoice is paid. This is referred to as the three-way match. The three-way match can be modified to expedite payments. For example, three-way matching may be limited solely to large-value invoices, or the matching is automatically approved if the received quantity is within a certain percentage of the amount authorized in the purchase order.

Notes Payable

A note payable is a liability where one party makes an unconditional written promise to pay a specific sum of money to another.

Definition of Promissory Note

A promissory note is a negotiable instrument, where one party (the maker or issuer) makes, under specific terms, an unconditional promise in writing to pay a determined sum of money to the other (the payee ), either at a fixed or determinable future time or on demand by the payee. The terms of a note usually include the principal amount, interest rate (if applicable), parties involved, date, terms of repayment (which may include interest), and maturity date. Sometimes, provisions are included concerning the payee's rights in the event of a default, which may include foreclosure of the maker's assets. Demand promissory notes are notes that do not carry a specific maturity date, but are due on demand by the lender. Usually the lender will only give the borrower a few days notice before the payment is due. For loans between individuals, writing and signing a promissory note are often instrumental for tax and record keeping purposes.

Accounting for Notes Payable

Negotiable promissory notes are used extensively in combination with mortgages in the financing of real estate transactions. Notes are also issued, along with commercial papers, to provide capital to businesses. When a note is signed and it becomes a binding agreement, a notes payable can be recorded to report the debt on the balance sheet. To report the note as a current liability it should be due within a 12-month period or current operating cycle, whichever is longer. The note payable amount can include the principal as well as the interest payment amounts due. If periodic payments are made throughout the term of the note, the payments will reduce the notes payable balance. It's important not to confuse a note with a loan contract, which is a legally distinct document from a note. It is non-negotiable, and does not include an unconditional promise to pay clause.

Current Maturities of Long-Term Debt

The portion of long-term liabilities that must be paid in the coming 12-month period are classified as current liabilities.

Definition of Long-Term Debt

Long-term liabilities are liabilities with a due date that extends over one year, such as a notes payable that matures in 2 years. In accounting, the long-term liabilities are shown on the right side of the balance sheet, along with the rest of the liability section, and their sources of funds are generally tied to capital assets. Examples of long-term liabilities are debentures, bonds, mortgage loans and other bank loans (it should be noted that not all bank loans are long term since not all are paid over a period greater than one year. ) Also long-term liabilities are a way for a company to show the existence of debt that can be paid in a time period longer than one year, a sign that the company is able to obtain long-term financing.

Long-Term Debt Due in the Current Period

The portion of long-term liabilities that must be paid in the coming 12-month period are classified as current liabilities. The portion of the liability considered "current" is moved from the long-term liabilities section to the current liabilities section. The position of where the debt should be disclosed is based on its maturity date in relation to the due date of other current liabilities. For example, a loan for which two payments of USD 1,000 are due--one in the next 12 months and the other after that date--would be split into one USD 1000 portion of the debt classified as a current liability, and the other USD 1000 as a long-term liability (note this example does not take into account any interest or discounting effects, which may be required depending on the accounting rules that may apply). If the current liability section already has an accounts payable account (balance which is usually paid off in 30 days), the current portion of the loan payable (due within 12 months) would be listed after accounts payable.

Current Obligations Expected to Be Refinanced

Per FASB 6, current obligations that an enterprise intends and is able to refinance with long term debt have different reporting requirements.

Definition of Refinancing

Refinancing may refer to the replacement of an existing debt obligation with a debt obligation under different terms. The terms and conditions of refinancing may vary widely by the type of debt involved and is based on several economic factors such as:

• the inherent and projected risk of the asset(s) backing the loan,
• the financial stability of the lender,
• credit availability,
• banking regulations,
• the borrower's credit worthiness, and
• the borrower's net worth.

If the replacement of debt occurs under financial distress, refinancing might be referred to as debt restructuring. The most common type of debt refinancing occurs in the home mortgage market.

Reasons to Refinance Debt

A loan or other type of debt can be refinanced for various reasons:

1. To take advantage of a better interest rate or loan terms (a reduced monthly payment or a reduced term)
2. To consolidate other debt(s) into one loan (a potentially longer/shorter term contingent on interest rate differential and fees)
3. To reduce the monthly repayment amount (often for a longer term, contingent on interest rate differential and fees)
4. To reduce or alter risk (e.g. switching from a variable-rate to a fixed-rate loan)
5. To free up cash (often for a longer term, contingent on interest rate differential and fees)

Risks of Refinanced Debt

Calculating the up-front, ongoing, and potentially variable transaction costs of refinancing is an important part of the decision on whether or not to refinance. If the refinanced loan has lower monthly repayments or consolidates other debts for the same repayment, it will result in a larger total interest cost over the life of the loan and will result in the borrower remaining in debt for many more years. Most fixed-term loans are subject to closing fees and points and have penalty clauses that are triggered by an early repayment of the loan, in part or in full.

Penalty clauses are only applicable to loans paid off prior to maturity and involve the payment of a penalty fee. The above-mentioned items are considered the transaction fees on the refinancing. These fees must be calculated before substituting an old loan for a new one, as they can wipe out any savings generated through refinancing.

In some jurisdictions, refinanced mortgage loans are considered recourse debt, meaning that the borrower is liable in case of default, while un-refinanced mortgages are non-recourse debt.

Dividends Payable

Dividends are payments made by a corporation to its shareholders; the payment amount is reported as dividends payable on the balance sheet.

Dividends are the portion of corporate profits paid out to shareholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be distributed to shareholders as dividends.

There are two ways to distribute cash to shareholders: share repurchases (reported as treasury stock in the owner's equity section of the balance sheet) or dividends.

Many corporations retain a portion of their earnings and pay out the remaining earnings as a dividend. A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to the shares he owns -- for example, if shareholder Y owns 100 shares when company Z declares a dividend of USD 1.00 per share. then shareholder Y will receive a dividend of USD 100 for his shares.

For the company, a dividend payment is not an expense, but the division of after tax profits among shareholders. On the dividend declaration date, a company's board of directors announces its intention to pay a dividend to shareholders on record as of a certain date (date of record). The per share dividend amount is multiplied by the number of shares outstanding and this result is debited to retained earnings and credited to dividends payable.

Dividends payable is recorded as a current liability on the company's books; the journal entry confirms that the dividend payment is now owed to the stockholders. On the declaration date, the Board announces the date of record and a payment date; the payment date is the date when the funds are sent to the shareholders and the dividends payable account is reduced for the payment amount.

Unearned and Deferred Revenues

A deferred revenue is recognized when cash is received upfront for a product before delivery or for a service before rendering.

Definition of Deferred and Unearned Revenues

A deferred item, in accrual accounting, is any account where a revenue or expense, recorded as an liability or asset, is not realized until a future date (accounting period) or until a transaction is completed. Examples of deferred items include annuities, charges, taxes, income, etc. If the deferred item relates to an expense (cash has been paid out), it is carried as an asset on the balance sheet. If the deferred item relates to revenue (cash has been received), it is carried as a liability. A deferred revenue is specifically recognized when cash is received upfront for a product before delivery or for a service before rendering. In these cases, the earnings process is not complete when the cash is received, so the cash is recorded as a liability for the products or services that are due to the buyer.

Accounting for Deferred and Unearned Revenues

An example of a deferred revenue is the monies received for a 12-month magazine subscription. The proceeds on the subscription relate to a future benefit (magazine) for the buyer that he will receive over the course of 12 months. Since the seller has received full payment for all 12 issues that will be delivered over the course of the year, the payment is recorded as unearned or deferred revenue in the current liability section of the balance sheet. If cash received is for benefits that extend past the current accounting period, a long-term liability would be recorded instead. As each magazine is delivered to the buyer (earnings process is now complete), the applicable "earned" portion of the original payment is transferred from the liability account to subscription revenue, which is disclosed on the income statement.

Other Current Liabilities: Sales Tax, Income Tax, Payroll, and Customer Advances

Other current liabilities reported on the balance sheet are sales tax, income tax, payroll, and customer advances (deferred revenue).

Other Current Liabilities

Sales Tax Payable

The sales and use tax is a tax paid to a governing body by a seller for the sales of certain goods and services. The payment of the tax by the seller occurs periodically and varies depending on the jurisdiction. Usually laws allow (or require) the seller to collect funds for the tax from the consumer at the point of purchase. Laws may allow sellers to itemized the tax separately from the price of the goods or services, or require it to be included in the price (tax-inclusive). The tax amount is usually calculated by applying a percentage rate to the taxable price of a sale. Sales tax payable can be accrued on a monthly basis by debiting sales tax expense and crediting sales tax payable for the tax amount applicable to monthly sales. The sales tax payable account is reported in the current liability section of the balance sheet until the tax is paid.

Income Tax Payable

Income tax is a tax levied on the income of individuals or businesses (corporations or other legal entities). Corporate tax refers to a direct tax levied on the net earnings made by companies or associations and often includes the capital gains of a company. Net earnings are generally considered gross revenue minus expenses. Expenses can vary; for example, corporate expenses related to fixed assets are usually deducted in full over their useful lives by using percentage rates based on the class of asset to which they belong. Accounting principles and tax rules about recognition of expenses and revenue will vary at times, giving rise to book-tax differences. If the book-tax difference is carried over more than a year, it is referred to as a deferred tax. Future assets and liabilities created by a deferred tax are reported on the balance sheet. Income tax payable can be accrued by debiting income tax expense and crediting income tax payable for the tax owed; the payable is disclosed in the current liability section until the tax is paid.

Salaries and Wages Payable

Wages and salaries in cash consist of wages or salaries payable at regular weekly, monthly, or other intervals, including payments by results and piecework payments, plus allowances like:

• working overtime;
• amounts paid to employees away from work for short periods (e.g., on holiday);
• ad hoc bonuses and similar payments;
• commissions, gratuities and tips received by employees.

Customer Advances (Deferred Revenue)

Deferred revenue is, in accrual accounting, money received for goods or services that have not yet been delivered and revenue on the sale has not been earned. According to the revenue recognition principle, the deferred amount is recorded as a liability until delivery is made, at which time it is converted into revenue. An example of a typical customer advance is the receipt of an annual maintenance contract fee, where the entire contract is paid up front. The receipt of $12,000 for the annual maintenance contract is initially recorded as deferred revenue. As the maintenance service is rendered and a portion of the fee is earned, $1,000 is recognized periodically each month as revenue and the deferred revenue account is reduced.

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