CHAPTER THREE

CURRENT LIABILITIES
3.1 The nature of liabilities
Liabilities are defined as “creditors’ claims on total assets” and as “existing debts and
obligations.” Companies must settle or pay these claims, debts, and obligations at some time
in the future by transferring assets or services. The future date on which they are due or
payable (the maturity date) is a significant feature of liabilities.

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).

Because liabilities involve future disbursements of assets or services, one of their most
important features is the date on which they are payable. A company must satisfy currently
maturing obligations in the ordinary course of business to continue operating. Liabilities with
a more distant due date do not, as a rule, represent a claim on the company’s current
resources. They are therefore in a slightly different category. This feature gives rise to the
basic division of liabilities into (1) current liabilities and (2) non-current liabilities.

A current liability is reported if one of two conditions exists:

1. The liability is expected to be settled within its normal operating cycle; or
2. The liability is expected to be settled within 12 months after the reporting date.

A current liability is a debt that a company expects to pay within one year or the operating
cycle, whichever is longer. Debts that do not meet this criterion are non-current liabilities.
Financial statement users want to know whether a company’s obligations are current or non-
current. A company that has more current liabilities than current assets often lacks liquidity,
or short-term debt-paying ability. In addition, users want to know the types of liabilities a
company has. If a company declares bankruptcy, a specific, predetermined order of payment
to creditors exists. Thus, the amount and type of liabilities are of critical importance.

3.2 Types of current Liabilities

The different types of current liabilities include notes payable, accounts payable, unearned
revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable. In the
sections that follow, we discuss common types of current liabilities.

1. Notes Payable
Companies record obligations in the form of written notes as notes payable. Notes payable
are often used instead of accounts payable because they give the lender formal proof of the
obligation in case legal remedies are needed to collect the debt. Companies frequently issue
notes payable to meet short-term financing needs. Notes payable usually require the borrower

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to pay interest. Notes are issued for varying periods of time. Those due for payment within
one year of the statement of financial position date are usually classified as current liabilities.

To illustrate the accounting for notes payable, assume that Hong Kong National Bank agrees
to lend HK$100,000 on September 1, 2017, if C. W. Co. signs a HK$100,000, 12%, four
month note maturing on January 1. When a company issues an interest-bearing note, the
amount of assets it receives upon issuance of the note generally equals the note’s face value.
C. W. Co. therefore will receive HK$100,000 cash and will make the following journal entry.

Interest accrues over the life of the note, and the company must periodically record that
accrual. If C. W. Co. prepares financial statements annually, it makes an adjusting entry at
December 31 to recognize interest expense and interest payable of HK$4,000 (HK$100,000 ×
12% × 4/12). The following illustration shows the formula for computing interest and its
application to C. W. Co.’s note.

C. W. Co. makes an adjusting entry as follows.

In the December 31 financial statements, the current liabilities section of the statement of
financial position will show notes payable HK$100,000 and interest payable HK$4,000. In
addition, the company will report interest expense of HK$4,000 under “Other income and
expense” in the income statement. If C. W. Co. prepared financial statements monthly, the
adjusting entry at the end of each month would have been HK$1,000 (HK$100,000 × 12% ×
1/12).

At maturity (January 1, 2018), C. W. Co. must pay the face value of the note (HK$100,000)
plus HK$4,000 interest (HK$100,000 × 12% × 4/12). It records payment of the note and
accrued interest as follows.

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 2. Sales Taxes Payable
Many of the products we purchase at retail stores are subject to sales taxes. Many
governments also are now collecting sales taxes on purchases made on the Internet as well.
Sales taxes are expressed as a percentage of the sales price. The selling company collects the
tax from the customer when the sale occurs. Periodically (usually monthly), the retailer
remits the collections to the government’s department of revenue.

Under most government sales tax laws, the selling company must enter separately on the cash
register the amount of the sale and the amount of the sales tax collected. The company then
uses the cash register readings to credit Sales Revenue and Sales Taxes Payable. For
example, if the March 25 cash register reading for Cooley Grocery shows sales of NT$10,000
and sales taxes of NT$600 (sales tax rate of 6%), the journal entry is as follows.

When the company remits the taxes to the taxing agency, it debits Sales Taxes Payable and
credits Cash. The company does not report sales taxes as an expense. It simply forwards to
the government the amount paid by the customers. Thus, Cooley Grocery serves only as a
collection agent for the taxing authority.

Sometimes companies do not enter sales taxes separately in the cash register. To determine
the amount of sales in such cases, divide total receipts by 100% plus the sales tax percentage.
For example, assume that Cooley Grocery enters total receipts of NT$10,600. The receipts
from the sales are equal to the sales price (100%) plus the tax percentage (6% of sales), or
1.06 times the sales total. We can compute the sales amount as follows.

NT$10,600 ÷ 1.06 = NT$10,000

Thus, we can find the sales tax amount of NT$600 by either (1) subtracting sales from total
receipts (NT$10,600 - NT$10,000) or (2) multiplying sales by the sales tax rate (NT$10,000
× .06).

3. Unearned Revenues
An airline company often receives cash when it sells tickets for future nights. A magazine
publisher receives customers’ payments when they order magazines. Season tickets for
concerts, sporting events, and theater programs are also paid for in advance. How do
companies account for unearned revenues that are received before goods are delivered or

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services are performed?
1. When a company receives the advance payment, it debits Cash and credits a
current liability account identifying the source of the unearned revenue.
2. When the company recognizes revenue, it debits an unearned revenue account and
credits a revenue account.

To illustrate, assume that the Busan IPark (KOR) sells 10,000 season football tickets at
$50,000 each for its five-game home schedule. The club makes the following entry for the
sale of season tickets (in thousands of $).

As each game is completed, Busan IPark records the recognition of revenue with the
following entry (in thousands of $).

The account Unearned Ticket Revenue represents unearned revenue, and Busan IPark reports
it as a current liability. As the club recognizes revenue, it reclassifies the amount from
unearned revenue to Ticket Revenue. Unearned revenue is substantial for some companies. In
the airline industry, for example, tickets sold for future nights represent almost 50% of total
current liabilities. The illustration below shows specific unearned revenue and revenue
accounts used in selected types of businesses.

4. Current Maturities of Long-Term Debt

Companies often have a portion of long-term debt that comes due in the current year. That
amount is considered a current liability. As an example, assume that Wendy Construction
issues a five-year, interest-bearing €25,000 note on January 1, 2017. This note specifies that
each January 1, starting January 1, 2018, Wendy should pay €5,000 of the note. When the
company prepares financial statements on December 31, 2017, it should report €5,000 as a
current liability and €20,000 as a non-current liability. (The €5,000 amount is the portion of
the note that is due to be paid within the next 12 months.) Companies often identify current
maturities of long-term debt on the statement of financial position as long-term debt due
within one year.

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It is not necessary to prepare an adjusting entry to recognize the current maturity of long-term
debt. At the statement of financial position date, all obligations due within one year are
classified as current and all other obligations as non-current.

3.3 Presentation of current liabilities on the statement of financial position

Current liabilities are presented after non-current liabilities on the statement of financial
position. Each of the principal types of current liabilities is listed separately. In addition,
companies disclose the terms of notes payable and other key information about the individual
items in the notes to the financial statements.

Companies seldom list current liabilities in the order of liquidity. The reason is that varying
maturity dates may exist for specific obligations such as notes payable. A more common
method of presenting current liabilities is to list them by order of magnitude, with the largest
ones first. Or, as a matter of custom, many companies show notes payable first and then
accounts payable, regardless of amount. Then the remaining current liabilities are listed by
magnitude. The following illustration shows this form of presentation.