Current Liabilities - Summary Principles of Accounting PDF

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Current Liabilities - Summary Principles of Accounting...

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Current Liabilities A current liability is one which is expected to be paid out of current assets within one year or the operating cycle of the business, whichever is longer. Examples of current liabilities include Accounts Payable and Notes Payable.

Notes Payable The text describes the accounting procedure for Notes Payable: Example: Johnson Company borrows $100,000 on March 1 for four months at 12% interest. The interest amount for the four month period would be $100,000 * .12 * 4/12 = $4000. The formula for interest calculation is Interest = Principal times Rate times Time, with the time expressed in years or a fraction of a year. Always take care in your calculation of time. In this example, interest needs to be calculated for March, as well as April, May, and June -- because the money is borrowed on March 1. If the company closes its books monthly, an adjustment would be made at the end of each month for interest accrued. For example, at the end of March, one month has elapsed, and $1,000 of interest expense ($100,000 * .12 * 1/12) is accrued:

After four months, the Interest Payable would amount to $4,000, and the entry to record payment would require a debit to Interest Payable for $4,000, a debit to Notes Payable for $100,000, and a credit to Cash for $104,000..

Sales Taxes Payable Many states levy a sales tax on certain items. The retailer is in a position to collect the tax at the moment of sale. After collection, the tax becomes a liability for the retailer. Therefore, the retailer is not incurring a sales tax expense; rather, the retailer is acting only as a collection agent. Periodically, the retailer is required, by state law, to remit the taxes collected to the state. If sales taxes are not accounted for separately, the retailer may have to determine the amount of sales tax rung up. For example, if $1,000 was taken in, how much of the $1,000 is sales tax, if the sales tax rate is 6%? One approach is to use algebra. Let S = sales for the day. S + .06S = 1000; or, 1.06S = 1000; S = 943.40. The sales tax liability = 943.40 * .06 = 56.60. These amounts could be checked against the cash register tape for reasonableness.

Unearned Revenues

An Unearned Revenue occurs when someone pays us for services that we will provide in the future. Remember that the general rule is that we do not record revenues until they are earned. If cash comes in before we perform the service, debit Cash and credit Unearned Revenue. Unearned Revenue is a current liability and is reported on the balance sheet. When we perform the service for which the advance payment was made, we debit Unearned Revenue and credit Fees Earned. Some typical examples where Unearned Revenues occur include: purchase of season tickets for the Seattle Seahawks, and payment of a lawyer's retainer. In both cases, the party who will provide the product receives cash before earning the revenue.

Current Portion of Long Term Debt If a company has purchased real estate, such as a building, the debt incurred for the asset’s purchase will be in the form of a mortgage payable. Although we think of a mortgage as a long term liability, payments are made each month. The debt to be paid off within one year is considered a current liability, and is reported separately from the remainder of the mortgage. Example: Our company purchased an office for $100,000 and signed a mortgage payable for that amount. In addition to the interest that we will pay this year, the principal of the note will be reduced by $6,000. The $6,000 would be reported as a current liability; the remainder of the debt ($94,000) would be reported as Mortgage Payable in the Long Term Liabilities section of the balance sheet. This is a case in which the Mortgage Payable has a balance of $100,000, but on the balance sheet, we report $6,000 as a current liability, and the remaining $94,000 as a long term liability.

Contingent Liabilities As the name implies, a Contingent Liability is one which may or may not result in an obligation to pay. Contingent liabilities result from lawsuits, misunderstandings or differences of opinion with the Internal Revenue Service, or other claims. The question is: should a liability be recorded on the books? According to GAAP, a liability should be recorded if the contingent event is probable and can be reasonably estimated. If the contingent liability is only reasonably possible, disclosure of the item should be made in the notes to the financial statements. If the contingent liability is only remotely possible, it need not be recorded or disclosed. This discussion of contingent liabilities is important because warranties are so prevalent with merchandisers. Warranty expenses are recorded as current liabilities even if customers have not returned the faulty merchandise as yet. In fact, the incurrence of the warranty liability occurs at the moment of sale. The only requirement is that the warranty costs must be probable and estimable. Like depreciation, warranty costs are estimated, and the estimate can be altered over time.

Warranty Expenses One example of a type of contingent liability that is usually recorded as an actual liability is that of Warranty Expenses arising from sale of a product. If the requirements shown above are met, (that warranty costs are probable for the product and can be estimated), then a liability is recorded. The journal entry would be a debit to Warranty Expense, and a credit to Estimated Warranty Liability. If a customer brings back a defective product and insists on a refund, a debit is made to Estimated Warranty Liability, and a credit is made to Cash....