Current liabilities are obligations that must be paid within one year or within the operating cycle, whichever is longer. Another requirement for classification as a current liability is the expectation that the debt will be paid from current assets (or through the rendering of services). Liabilities that do not meet these conditions are classified as longterm liabilities.
The time period used in defining current liabilities.parallels that used in defining current assets. The amount of working capital (current assets less current liabilities) and the current ratio (current assets divided by current liabilities) are valuable indicators of a company’s ability to pay its debts in the near future.Among the most common .examples of current liabilities are accounts payable, short-term notes payable, the current portion of long-term debt, accrued liabilities (such as interest payable, income taxes payable, and payroll liabilities). and unearned revenue. Accounts Payable Accounts payable often are subdivided into the categories of trade accounts payable and other accounts payable.
Trade accounts payable are short-term obligations to suppliers for purchases of merchandise. Other accounts payable include Liabilities for any goods and services other than merchandise. Technically, the date .at which a trade account payable comes into existence depends on whether goods are purchased EO.B. shipping point or F.0.B. destination.
Under EO.B. shipping point, a liability arises and title to the goods transfers when the merchandise is shipped by the supplier. Under F.O.B. destination, a liability does not arise and title of ownership does not transfer until the goods are actually received by the buyer. However, unless material amounts of merchandise are purchased on terms EO.B. shipping point, most companies follow the convenient practice of recording trade accounts payable when merchandise is received .
Notes Payable Notes payable are issued whenever bank loans are obtained, Other transactions that may give rise to notes payable include the purchase of real estate or costly equipment, the purchase of merchandise, and the substitution of a note for a past-due account payable. . Notes payable usually require the borrower to pay an interest charge.
Normally, the interest rate is stated separately from the principal amount o9fPe note? To illustrate, assume that on November 1 Porter Company borrows $10,000 from its bank for a period of six months at an annual interest rate of 12%. Six months later on May 1, Porter Company will have to pay the bank the principal amount of $10,000, plus $60()interest ($10,000 X .12 X ~h).
As evidence of this loan, the bank will require Porter Company to issue a note payable similar to the one illustrated-at the top of the following page
The journal entry in Porter Company’s accounting records for this November 1 borrowing is:Cash , 10,000 Notes Payable 10,000 Borrowed $10,000 for 6 months at 12%.interest per year. Notice that no liability is recorded for the interest charges when the. note is issued. At the date that money is borrowed, the borrower has a liability onlyfor the principal amount of the loan; the liability for interest accrues day by day over the life of the loan.
At December 31, two months’ interest expense has accrued, and the following year-end adjusting entry is made: Interest Expense 200 Interest Payable 200 To record interest expense incurred through year-end on 12%, 6-month note dated Nov. 1,($10,000. x 12% x 0/12 = $200). For simplicity, we will assume that
Porter Company makes adjusting entries only at year-end. Thus the entry ‘on May \ to record payment of the note will be: Notes Payable Intl’re8t Payable Interest Expense Cash To recOrd payment of 12%, 6-month note on maturity date and to recognize Interest expense incurred since Jan. 1 ($10,000 x 12% x ~12 = $400). If Porter Company paid this note prier to May I, interest charges usually would be computed only through the date of early payment. 3 10,000 200 400 10,600 .
The Current Portion of long-Term Debt Some long-term debts, such as mortgage loans, are payable in a series of monthly or quarterly installments. In these cases, the principal amount due within one year (or the operating cycle) is regarded as a current liability, and the remainder of the obligation is classified as a long-term liability.
As the maturity date of a long-term liability approaches, the obligation eventually ‘becoes due within the current period. Long-term liabilities ‘that become payable within 3Computing interest charges Oldy through the date of paymlmt is the normal business practice. However, some notes are written in a manner requiring the borrower to pay interest for the full tenn of the note even if payment is made early, Borrowers should look car.efully at these f&t’Ins.the coming year are reclassified in the balance sheet as current liabilities;” Changing the classification of a liability does not require a journal entry; the obligation merely is shown in a different section of the balance sheet.
Accrued Liabilities Accrued UabUltles arise from the recognition of expenses for which payment will be made in a future period. Thus accrued liabilities also are called accrued expenses. Ex- ,amples of accrued liabilities include interest payable, income taxes payable, and a num. ber of liabilities relating to payrolls. As accrued liabilities stem .from the recording of e)opens the matching principle governs the .timing of their recognition AU’companies incur accrued liabilities. In most cases
•.however, these liabilities are paid at frequent intervals. Therefore, ‘they usually do not accumulate to large amounts. In il balance sheet, accrued liabilities frequently are included in .the. amount shown as accounts payable.