Chapter 3: Current Liabilities

(4 hours)
Session 12
Topics: The basics of accounting for current liabilities
Learning Objective
At the end of this session, students are expected to:
- Explain a current liability, and identify the major types of current liabilities
- Describe the accounting for notes payable.
- Explain the accounting for other current liabilities.
- Understand the financial statement presentation of current liabilities
Reading text

3.1 Introduction to the Nature of Liabilities

The IASB, as part of its Conceptual Framework, 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).

3.2 Classification of Liabilities

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. The
following part of these session focuses on the current liabilities.

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Illustration
Identify whether obligations are current liabilities. Cardinal Company has the following
obligations at December 31:
(a) A note payable for Br.100,000 due in 2 years,
(b) A 10-year mortgage payable of Br. 300,000 payable in ten Br. 30,000 annual payments,
(c) Interest payable of Br. 12,000 on the mortgage, and
(d) Accounts payable of Br. 60,000. For each obligation, indicate whether it should be classified
as a current liability. (Assume an operating cycle of less than one year.)
Current liabilities generally are obligations that the company is to pay within the coming year
or its operating cycle, whichever is longer. Within the current liabilities section, companies
usually list notes payable first, followed by accounts payable.
Most companies pay current liabilities within one year by using current assets rather than by
creating other liabilities. Companies must carefully monitor the relationship of current liabilities
to current assets. This relationship is critical in evaluating a company’s short-term debt paying
ability. A company that has more current liabilities than current assets may not be able to meet
its current obligations when they become due.

3.3 Types of 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.
Here are some typical current liabilities:
1. Accounts payable. 6. Customer advances and deposits.
2. Notes payable. 7. Unearned revenues.
3. Current maturities of long-term debt. 8. Sales and value-added taxes refinanced.
4. Short-term obligations expected to be payable. 9. Income taxes payable
. 5. Dividends payable. 10. Employee-related liabilities.

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 1.3.1. Accounts Payable
Accounts payable or trade accounts payable, are balances owed to others for goods, supplies,
or services purchased on open account. Accounts payable arise because of the time lag between
the receipt of services or acquisition of title to assets and the payment for them. The terms of the
sale, (e.g., 2/10, n/30 or 1/10, E.O.M.), usually state this period of extended credit, commonly 30
to 60 days.

Most companies record liabilities for purchases of goods upon receipt of the goods. If title has
passed to the purchaser before receipt of the goods, the company should record the transaction at
the time of title passage. A company must pay special attention to transactions occurring near the
end of one accounting period and at the beginning of the next. It needs to ascertain that the
record of goods received (the inventory) agrees with the liability (accounts payable), and that it
records both in the proper period.

To illustrate the difference between the gross and net methods, assume the following
transactions.
Gross Method Net Method
1. Purchase cost Br.10,000, terms 2/10, net 30
Purchases 10,000 Purchases 9,800
Accounts Payable 10,000 Accounts Payable 9,800

2. Invoices of Br. 4,000 are paid within discount period

Accounts Payable 4,000 Accounts Payable 3,920
Purchase Discounts 80 Cash 3,920
Cash 3,920

3. Invoices of Br. 6,000 are paid after discount period

Accounts Payable 6,000 Accounts Payable 5,880
Cash 6,000 Purchase Discounts Lost 120
Cash 6,000

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 1.3.2. 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 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 a Addis microfinance agrees to lend
Br.100,000 on September 1, 2012. if Yanet stationary trading signs a Br. 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.
Yanet stationary trading therefore will receive Br. 100,000 cash and will make the following
journal entry.
 Sept. 1 Cash 100,000
Notes Payable 100,000
(To record issuance of 12%, 4-month note to Addis micro-finance)
Interest accrues over the life of the note, and the company must periodically record that accrual.
If Yanet stationary trading prepares financial statements annually, it makes an adjusting entry at
December 31 to recognize interest expense and interest payable of Br. 4,000 (Br. 100,000X12%
X 4/12).
Yanet stationary trading makes an adjusting entry as follows:
 Dec. 31 Interest Expense 4,000
Interest Payable 4,000
(To accrue interest for 4 months on Addis micro-finance note)

In the December 31 financial statements, the current liabilities section of the Statement of cash
flow will show notes payable Br. 100,000 and interest payable Br. 4,000.
In addition, the company will report interest expense of Br. 4,000 under “Other income and
expense” in the income statement.
If Yanet stationary trading prepared financial statements monthly, the adjusting entry at the end
of each month would have been Br. 1,000 (Br. 100,000X 12% X1/12).

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At maturity (January 1, 2015), Yanet stationary trading must pay the face value of the note (Br.
100,000) plus Br. 4,000 interest (Br. 100,000 X 12% X 4/12). It records payment of the note and
accrued interest as follows.
Jan. 1 Notes Payable 100,000
Interest Payable 4,000
Cash 104,000
(To record payment of Hong Kong National Bank interest-bearing note and accrued interest at
maturity)
Lecture Synopsis:
- The nature of Liabilities: an obligation payable within one accounting period or one year
whichever is long
- Classification of Liabilities
- Types of current liabilities
o Account payable: a liability bind by oral agreement
o Notes payable: an obligation evidenced by a written promise
Next day assignment
Study the following
- Accounting for
o Sales tax (Turn Over Tax-TOT) payable
o Value Added Tax (VAT) payable
o Unearned Revenues
o Current Maturities of Long-Term Debt
o Dividends Payable
o Presentation of Current Liabilities
Next week assignment
Exercise
1. If cash is borrowed on a Br. 50,000, 6-month, 12% note on September 1, how much
interest expense would be incurred by December 31?
2. Becky Company borrows Br. 60,000 on July 1 from the bank by signing a Br. 60,000,
10%, one-year note payable.

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 (a) Prepare the journal entry to record the proceeds of the note.
(b) Prepare the journal entry to record accrued interest at December 31, assuming adjusting
entries are made only at the end of the year
Session 13
3.3.3 Current Liabilities other than A/P and N/P
Learning objective:
At the end of this session, students are expected to:
- Understand the accounting treatment of current liabilities other than A/P and N/P
- Look for the Financial statement presentation of current liabilities
Reading assignment questions
a. Discuss the other types of current liabilities?
b. How do current liabilities presented in the Statement of Financial Position?

Reading text
A. Sales Taxes (Turn Over Tax -TOT)) Payable
As a consumer, you know that many of the products you 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 Gerji Stationary shows sales of Br. 10,000 and sales taxes of
Br. 200 (sales tax rate of 2%), the journal entry is:
Mar. 25 Cash 10,200
Sales Revenue 10,000
Sales Taxes Payable 200
(To record daily sales and sales taxes)

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Exercise
Meaza Auto Supply does not segregate sales and sales taxes at the time of sale. The register total
for March 16 is Br. 13,440. All sales are subject to a 2% sales tax. Compute sales taxes payable,
and make the entry to record sales taxes payable and sales.

B. Value-Added Taxes Payable

Value-added taxes (VAT) are used by tax authorities more than sales taxes (over 130 countries
require that companies collect a value-added tax). As indicted earlier, a value added tax is a
consumption tax. This tax is placed on a product or service whenever value is added at a stage of
production and at final sale. A VAT is a cost to the end user, normally a private individual,
similar to a sales tax(TOT).

Illustration
1. Addis Company grows wheat and sells it to Shewa Baking for Br. 10,000. Addis Company
makes the following entry to record the sale, assuming the VAT is 15 percent.
Cash……………………………………..11,500
Sales Revenue……………………………10,000
Value-Added Taxes Payable………………1,500
Addis Company then remits the Br. 1,500 to the tax authority.

2. Shewa Baking makes loaves of bread from this wheat and sells it to All Mart Supermarket for
Br. 20,000. Shewa Baking makes the following entry to record the sale, assuming the VAT is 15
percent.
Cash………………………………………23,000
Sales Revenue …………………………… 20,000
Value-Added Taxes Payable………………..3000
Shewa Baking then remits Br. 1,500 to the government, not Br. 3,000. The reason: Shewa
Baking has already paid Br. 1,500 to Addis Company. At this point, the tax authority is only
entitled to Br. 1,500. Shewa Baking receives a credit for the VAT paid to Addis Company, which
reduces the VAT payable.

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3. Chuchu Supermarket sells the loaves of bread to consumers for Br. 2,400. Chuchu
Supermarket makes the following entry to record the sale, assuming the VAT is 15 percent.
Cash 2,760
Sales Revenue 2,400
Value-Added Taxes Payable 360

C. Unearned Revenues
How do companies account for unearned revenues that are received before goods are delivered
or services are provided?

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 Buna Football club sells 10,000 season soccer tickets at Br. 50 each for
its five-game home schedule. Logo University records the sales of season tickets as follows.

August 6 Cash 500,000

Unearned Sales Revenue 500,000
(To record sale of 10,000 season tickets)

After each game, Buna club makes the following entry.

September 7 Unearned Sales Revenue 100,000
Sales Revenue 100,000
(To record soccer ticket revenue)

The account Unearned Sales Revenue represents unearned revenue. Buna club reports it as a
current liability in the statement of financial position because the school has a performance
obligation. As ticket holders attend games, Buna recognizes revenue and reclassifies the amount
from Unearned Sales Revenue to Sales Revenue.

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 D. 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 Nohi Construction issues a
five-year interest-bearing Br. 25,000 note on January 1, 2013. This note specifies that each
January 1, starting January 1, 2014, Nohi should pay Br. 5,000 of the note. When the company
prepares financial statements on December 31, 2013, it should report Br. 5,000 as a current
liability and Br. 20,000 as a non-current liability. (The Br. 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.
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 liabilities.

E. Dividends Payable
A cash dividend payable is an amount owed by a corporation to its shareholders as a result of
board of directors’ authorization (or in other cases, vote of shareholders). At the date of
declaration, the corporation assumes a liability that places the shareholders in the position of
creditors in the amount of dividends declared. Because companies always pay cash dividends
within one year of declaration (generally within three months), they classify them as current
liabilities.

Illustration
1. When a dividend is declared
Cash dividend 10,000
Dividend payable 10,000
2. When the dividend is paid
Dividend payable 10,000
Cash 10,000

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Until the cash dividend is paid to the shareholder, it will be reported as part of the Current
Liability in the “Statement of Financial Position”.

F. Employee-Related Liabilities will be discussed in chapter 4

Presentation of Current Liabilities
In practice, current liabilities are usually recorded and reported in financial statements at their
full maturity value. Because of the short time periods involved, frequently less than one year, the
difference between the present value of a current liability and the maturity value is usually not
large. The profession accepts as immaterial any slight overstatement of liabilities that results
from carrying current liabilities at maturity value.

The current liabilities accounts are commonly presented after non-current liabilities in the
statement of financial position. Within the current liabilities section, companies may list the
accounts in order of maturity, in descending order of amount, or in order of liquidation
preference.
Illustration
Glory Trading plc
Statement of Financial Position
December 31, 2017
(in millions)
Stockholders’ Equity and Liabilities
Current liabilities
Short-term borrowings (notes payable) Br. 4,083
Accounts payable 2,993
Accrued expenses 3,351
Accrued wages, salaries, and employee benefits 797
Customer advances 1,217
Dividends payable 262
Other current liabilities 888
Long-term debt due within one year 5,701
Total current liabilities Br. 19,292

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Lecture synopsis:
1. Sales tax( Turn-Over Tax) payable
o Sales tax included in the selling price
o Sales tax levied separately from the sales revenue
2. Value Added Tax (VAT) payable
o Actually paid by the final consumer of goods and services
3. Unearned Revenues
o Cash received in advance
4. Current Maturities of Long-Term Debt
5. Dividends Payable
6. Presentation of Current Liabilities: as part of liability it is presented in the statement of
financial position

Next day’s assignment

Study the following
- Payroll and payroll taxes
o Overview of Ethiopian employment
o Employee earning deduction
o Types of leaves and termination benefit
o Component of payroll sheet
o Payroll related journal entries
Next Week’s assignment
1. On October 1, 2016, Reed Travel Company borrowed Br. 40, 000 cash and signed a one-
year note payable, due on September 30, 2017. The going rate of interest for this level of
risk was 10 percent. The accounting period ends on December 31.
Required: Compute the face amount of the note
2. Fasil Kenema sells 4,000 season football tickets at Br. 180 each for its 10- game home
schedule. Give the entry to record (a) the sale of the season tickets and (b) the revenue
recognized for playing the first home game.

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 3. You and several classmates are studying for the next accounting examination. They ask
you to answer the following questions:
A. If cash is borrowed on a Br. 70,000, 9-month, 9% note on August 1, how much
interest expense would be incurred by December 31?
B. The cash register total including sales taxes is Br. 42,000, and the sales tax rate is
5%. What is the sales taxes payable?
C. If Br. 42,000 is collected in advance on December 1 for 6-month magazine
subscriptions, what amount of subscription revenue is recognized by December 31?

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