Chapter 8: Reporting and Analyzing Current Liabilities
Learning Objectives
Explain, measure, and report current liabilities.
Identify and record the types of activities that produce current liabilities.
Explain contingent liabilities.
Definition of Current Liabilities
Current liabilities are:
Obligations that are expected to be retired with existing current assets or the creation of new current liabilities.
Due within one year or one operating cycle, whichever is longer.
Long-term liabilities are considered any obligations that do not meet the criteria for current liabilities.
Contingent liabilities can be either:
Current or long-term.
Are uncertain in two ways:
They may or may not turn into actual obligations.
For those that do become obligations, the timing and amount of the payment is uncertain.
Recognition, Measurement, and Reporting of Liabilities
Liabilities are defined as probable future sacrifices of economic benefits which result from past activities:
They require the business to transfer assets or provide services to another entity in the future.
Future outflows related to liabilities may involve:
Payment of cash (may not always be the case).
Amounts that are known or uncertain (may not be known with certainty).
Legal enforceability, where some claims may be legally enforceable while others may not be.
Payments could be made to known or unknown recipients.
When a liability relies on a future event (contingent liability):
Recognition depends on how likely the future event is and whether a reasonable estimate of payment can be made.
Characteristics of Liabilities
Payment of Cash:
Liabilities usually require cash payment but may involve transfer of assets or performance of future services.
Certainty:
The exact amounts and timing of future payments are typically known, but may not be the case for some liabilities.
Legal Enforceability:
Many liabilities are legally enforceable, but some represent probable claims.
Payment Recipient:
Liabilities usually specify who will receive payment, but do not exclude payments to unknown recipients.
Recognition of Wages Owing to Employees as Current Liabilities
Wages are recognized as current liabilities when:
Work activities occur during the accounting period.
Transfer of assets to pay wages due to employees occurs.
As a result, wages owing to employees are reported as current liabilities.
Current Liability Overview
Current liabilities require payment of cash, transfer of another current asset, creation of a new current liability, or provision of goods/services within one year or one operating cycle.
Most firms operate with cycles shorter than one year, so the one-year rule is commonly applied.
Presentation of current liabilities may vary:
Some firms simplify while others detail them extensively.
Accounts Payable
Definition: An account payable arises when goods or services are purchased on credit.
It reflects the business’s obligation to another entity, which has a receivable due to the transaction.
Credit Terms: Generally require payment within 30 to 60 days and seldom demand interest payments.
Formal Agreement: Accounts payable do not necessitate a formal contract.
Accrued Liabilities
Unlike accounts payable, accrued liabilities:
Are recognized through adjusting entries.
Represent expenses incurred but not yet paid at the end of the accounting period.
Example:
Green's Landscaping pays $10,000 in wages ($1,000 per workday) every other Friday. If December 31 is the Tuesday before the payday, a liability must be accrued for wages.
Payment on January 3 would include 3 days’ pay as an expense of the current year and settle the Wages Payable for the previous year.
Short-Term Notes Payable
Definition: A note payable is initiated when borrowing or purchasing goods/services through a formal agreement.
Such formal agreements differentiate notes payable from accounts payable.
Details: Notes payable typically specify:
The amount to be repaid, known as the principal.
An interest rate, contributing to the concept of time value of money.
Recording Notes Payable and Accrued Interest (Cornerstone 8-1)
Example Information:
Business: Feldman Auto Parts
Loan Amount: $100,000 at 10% interest due October 1, 2023.
Year-End: December 31.
Required Entries:
Initial Entry on October 1, 2022:
Debit: Cash $100,000
Credit: Note Payable $100,000
(Record issuance of note payable)
Adjusting Entry on December 31, 2022:
Debit: Interest Expense $2,500
Credit: Interest Payable $2,500
(Record accrual of interest expense)
Entry on October 1, 2023:
Debit: Note Payable $100,000
Debit: Interest Expense $7,500
Credit: Interest Payable $2,500
Credit: Cash $110,000
(Record payment of note and interest)Where: $100,000 × 10% × 3/12 = $2,500, and $100,000 × 10% × 9/12 = $7,500.
Notes Payable from a Payment Extension
Notes payable can also emerge when a borrower cannot timely pay an account payable, resulting in:
A shift from an account payable to a short-term note payable.
Example:
On March 8, 2022, Gibson Shipping orders $25,000 worth of packing materials. Due May 15, 2022.
If payment cannot be made, an extension can turn the payable into a note with specified terms.
Current Portion of Long-Term Debt
The current portion of long-term debt is defined as:
The principal amount of long-term debt due within 12 months from the end of the accounting period.
At each accounting period's end, the due long-term debt reclassifies as a current liability, yet no journal entries are necessary for this reclassification.
Unearned (Deferred) Revenues
Definition: Unearned revenue is the liability created when customers prepay for goods/services.
This prepayment represents a liability until either:
Goods/services are provided, leading to revenue recognition.
The business refunds the prepayment amount.
A similar concept, customer deposits, is treated as a long-term liability when payments are not expected to be earned or returned soon enough to be classified as current liabilities.
Recording Unearned Revenues (Cornerstone 8-5)
Example Information:
Business: Luigi's Steakhouse
Sale of Gift Cards: $100,000 in December 2022; valid until December 31, 2023.
Redemption: $98,875 of gift cards redeemed in 2023.
Required Journal Entries:
Sale of Gift Cards in 2022:
Debit: Cash $100,000
Credit: Unearned Sales Revenue $100,000
(Record sale of gift cards)
Redemption of Gift Cards in 2023:
Debit: Unearned Sales Revenue $98,875
Credit: Sales Revenue $98,875
(Record redemption of gift cards)
Expiration of Remaining Gift Cards in 2023:
Debit: Unearned Sales Revenue $1,125
Credit: Sales Revenue $1,125
(Record expiration of gift cards)