12 - Current Liabilities LARRY WALTHER: I'm Larry Walther, this is principlesofaccounting.com Chapter 12. And this first module, the topic for consideration will be the nature and recording of typical current liabilities. The definition of the current liabilities in a very general sense would be debts that are due to be paid within one year or the operating cycle, whichever is longer. This typically, however, involves the use of current assets or the creation of another current liability or perhaps the providing of some service to satisfy an obligation. This recalls a recollection of the operating cycle, that's the length of time it takes to turn business cash back into business cash. A business might start with cash, buy inventory, sell those goods and carry a receivable, and then eventually collect the receivable. The length of time it takes to do that operating cycle, and that's part and parcel of considering the definition of a current liability. For most businesses the operating cycle is less than one year, but that's not always the case. Now, examples, accounts payable, these are amounts due to suppliers relating to the purchase of goods and services. They may be supported by a written agreement but typically it's based on an informal working relationship. Accounts payable are fairly obvious included in the current liability section. Another item not so obvious perhaps would be the current portion of long term debt. Debt of long duration is of course reported as a long term liability on the balance sheet, however the amount of principal that's due to be repaid within the operating cycle or one year, whichever is longer, should be separated and classified in the current liability section. Here's an example. We have a $100,000 note that's to be paid in equal annual installments of $10,000 each, plus accrued interest. At the end of any given year, $10,000 of the principal should be shown as a current liability, and the remaining balance would be shown in the non-current liability section. Accrued liabilities are another example of current liabilities. These are expenses that accumulate with the passage of time but will be paid in one lump sum amount in the future. An example would be wages that are due to employees. These accumulate each day or accrue each day as employees work for us. The amount that's owed to the employees at any point in time would be shown as an accrued liability wages payable, reported in the current liability section. When paid, of course, the liability would be removed from the books. Taxes and interests or other items that are often shown as an accruing liability amount. Prepayments by customers is another current liability. When customers deposit money in advance of receiving the expected goods or services. Those deposited moneys will be shown as a current liability because they represent an obligation to either return the money or provide the service. These amounts are often called unearned revenue. They're removed and recognized in revenue as the goods and services are provided. Examples would be selling magazine subscriptions in advance, selling gift cards, tickets for an airline or a concert or something of that nature. All of the money that's paid by the customer to the company in advance of the service being provided would be carried as a liability until it's earned by the provider of the services. Collections for third parties is another important current liability that sometimes may not be considered. The receipt of some payment, where the recipient is not the beneficiary of the payment. The recipient has an obligation to remit those funds to another entity or another party. Those amounts would be shown as the current liabilities. Best example probably would be sales tax. When a store sells goods and collects in addition to the sales price, the sales tax on the transaction, that company has an obligation to in turn, remit that sales tax to a city or state taxing organization. So the amount of the transaction that's reflective of the sales tax would be carried as current liability. Obligations that are expected to be refinanced raise interesting questions. Sometimes the company has a long term note that is coming due and they tend to essentially pay it off by borrowing from another lender or even from the same lender in a new transaction. These are amounts or obligations that we expect to refinance rather than actually paying off. Now these amounts should be shown as a current liability for the year prior to their due date unless there's intent and an ability to refinance on a long-term basis. So I say, currently between long-term obligations, to be shown as a current liability, unless the company both intends to renew the debt on a long-term basis. And the company has the demonstrated ability to do so which is usually evidenced by some firm agreement from a competent lender that's able to execute on their part of the transaction.