8.1 Current Liabilities: Known Amounts

Liabilities are present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits.

There are two types of liabilities on the classified balance sheet:

1. Current liabilities: maturity less than one year or within the operating cycle, if longer than one year.
2. Non-current liabilities: maturity more than one year or beyond the operating cycle, if longer than one year.

Current Liabilities

As discussed, current liabilities are obligations due within one year or within the company’s normal operating cycle if longer than one year.

There are two types of current liabilities:

1. Known amounts
   For example, short-term borrowings, accounts payable, accrued liabilities, short-term notes payable, sales tax payable, payroll liabilities, income tax payable, unearned revenues, and current portion of long-term debt.
2. Estimated amounts
   For example, warranties, provisions, and contingent liabilities.

(Harrison et al., 2018, p. 376)

Known Amounts

Short-Term Borrowings

Short-term borrowings are amounts owed to banks or other lenders. Small and large businesses alike sometimes need to borrow money to manage their working capital needs and meet short-term obligations in their business. For example, a mom-and-pop grocery store might need to use its line of credit to pay suppliers at the beginning of the month, because of a cash shortfall from delayed cash receipts. A line of credit allows a company to access credit on an as-needed basis up to a maximum amount set by the lender.

(Harrison et al., 2018, p. 376)

Accounts Payable

Accounts payable are amounts owed to suppliers for goods or services purchased on account. Usually, one of merchandisers’ most common transactions is the credit purchase of inventory. Normally, accounts payable need to be paid within 30-60 days. 

Short-Term Notes Payable

In a previous unit, we introduced the concept of “notes receivable” or promissory notes. A notes receivable in the lender’s books is recorded as notes payable in the borrower’s books.

A note payable specifies the amount borrowed, the date by which it must be paid, and the interest rate associated with the borrowing. Short-term notes are notes due within one year and can be borrowed in cash or against an asset. On its notes payable, a company accrues interest expense at the end of each reporting period.

Let’s analyze journal entries to record a note payable

(1) Issuance of note:

(2) Accrual of interest:

(3) Payment of note at maturity:

Example:

On September 1, 2020, Apple Inc. purchases parts for its new iMac for $75 million by issuing an 8-month, 5% note payable. The fiscal year ends on January 31. The note payable is due on April 30, 2021.

The following sequence of entries covers the (1) issuance of note upon purchase of parts, (2) accrual of interest expense, and (3) payment of a short-term note payable and its interest at maturity.

(1) Issuance of note:

(2) Accrual of interest (4 months until December 31):

(3) Payment of note at maturity:

Taxes Payable

The federal government and most provincial governments levy taxes on the sale of goods and services.

Sellers add these taxes to the sales price, collect them from customers, and then remit them to the respective governments periodically (monthly, quarterly, annually). Thus, sellers act as intermediaries between the customer and the governments.

The sales taxes collected from customers represent liabilities for the sellers between the date of collection and the date of remittance to the government.

Canada has three types of sales taxes:

1. GST (Goods and Services Tax) is a value-added tax levied by the federal government. It applies to most goods and services.
2. PST (Provincial/Regional Sales Tax) is a retail tax applied to goods and services purchased by individuals or businesses for their own use, not for resale, with rates varying by province or region.
3. HST (Harmonized Sales Tax) which combines PST and GST, is also a value-added tax. 

(Harrison et al., 2018, p. 379)

Accrued Liabilities

An accrued liability usually results from an expense that the business has incurred but not yet paid. Therefore, an accrued expense creates a liability, which explains why it is also called an accrued expense.

For example, a business’s salary expense and salary payable occur as employees work for the company. 

There are several categories of accrued expenses:

• Salaries and wages payable
• Interest payable
• Income taxes payable

(Harrison et al., 2018, p. 377)

Unearned Revenues

In a previous unit, we introduced a number of adjustment entries, including adjusting unearned or deferred revenues at year-end once “earned.” Businesses sometimes collect cash from their customers before earning the revenue (i.e., before they provide the goods/services to their customers). 

This results in a liability called unearned revenues. Once the revenue is earned, the unearned balance is adjusted down and revenues are adjusted up.

Current Portion of Long-Term Debt

Some long-term debt must be paid in installments. The current portion of long-term debt is the amount of the principal that is payable within one year from the balance sheet date. At the end of each year, a company reclassifies (from long-term debt to a current liability) the amount of its long-term debt that must be paid next year.

Let’s take a look at an example:

Apple Inc. received a 2-year loan for $30M on Jan. 1, 2020 with maturity in Dec. 31, 2021.

• $15M is due on Dec. 31, 2020, the maturity is less than one year, thus, this is reported as current portion of long-term debt
• $15M is due on Dec. 31, 2021, the maturity is more than one year, thus, this is a long-term liability