12 2 Analyze, Journalize, and Report Current Liabilities Principles of Accounting, Volume 1: Financial Accounting

This second journal entry is the same as the one that would have recognized an original purchase of $11,000 that qualified for a discount. Current liabilities are critical for modeling working capital when building a financial model. Transitively, it becomes difficult to forecast a balance sheet and the operating section of the cash flow statement if historical information on the current liabilities of a company is missing. Current liabilities are financial obligations of a business entity that are due and payable within a year.

2 Analyze, Journalize, and Report Current Liabilities

On March 31, the end of the first three months, Sierra records their first interest accumulation. When the company provides the uniforms on May 6, Unearned Uniform Revenue decreases (debit) and Uniform Revenue increases (credit) for $600. In a final possible scenario, assume that Sierra Sports remitted payment outside of the discount window on August 28, but inside of thirty days. In this case, they did not qualify for the discount, and assuming that they made no returns they paid the full, undiscounted balance of $12,000.

That’s where Enerpize Online Accounting Software makes a difference by automating liability tracking and delivering real-time financial insights, which helps businesses stay accurate, efficient, and in control. Understanding what falls under current liabilities is essential to maintaining accurate financial records and evaluating short-term liquidity. These examples of current liabilities are commonly used in financial statements and directly impact important metrics like the cash ratio, current ratio, and quick ratio.

Taxes Payable

The distinction between current and noncurrent liabilities is a function of time. A debt that is expected to be satisfied within one year from the date of the balance sheet is classified as a current liability1. Amounts owed for rent, insurance, utilities, inventory purchases, and the like usually fall into this category. If payment will not be made until after that one-year interval, the liability is reported as noncurrent. Bonds and notes payable are common examples of noncurrent debts as are liabilities for employee pensions, long-term leases, and deferred income taxes.

It is used to help calculate howlong the company can maintain operations before becoming insolvent.The proper classification of liabilities as current assistsdecision-makers in determining the short-term and long-term cashneeds of a company. Taxes payable refers to a liability created when a company collects taxes on behalf of employees and customers or for tax obligations owed by the company, such as sales taxes or income taxes. A future payment to a government agency is required for the amount collected.

Thismeans $24.06 of the $400 payment applies to interest, and theremaining $375.94 ($400 – $24.06) is applied to the outstandingprincipal balance to get a new balance of $9,249.06 ($9,625 –$375.94). These computations occur until the entire principalbalance is paid in full. For example, let’s say you take out a car loan in the amount of $10,000. The annual interest rate is 3%, and you are required to make scheduled payments each month in the amount of $400. You first need to determine the monthly interest rate by dividing 3% by twelve months (3%/12), which is 0.25%.

Accounting/journal entries for current liabilities

• Accounts Payable decreases (debit) for the original amount due, Inventory decreases (credit) for the discount amount of $240 ($12,000 × 2%), and Cash decreases (credit) for the remaining balance due after discount.
• This contract provides additional legal protection for the lender in the event of failure by the borrower to make timely payments.
• The liquidity of a liability is determined by the expected amount of time to elapse before it is met.
• Even though theoverall $100,000 note payable is considered long term, the $10,000required repayment during the company’s operating cycle isconsidered current (short term).
• If all of the treatments occur,$40 in revenue will be recognized in 2019, with the remaining $80recognized in 2020.

Therefore, 2/10, n/30 means Sierra Sports has ten days to pay its balance due to receive a 2% discount, otherwise Sierra Sports has net thirty days, in this case August 31, to pay in full but not receive a discount. FOB shipping point signals that since Sierra Sports takes ownership of the merchandise when it leaves the manufacturer, it takes responsibility for the merchandise in transit and will pay the shipping charges. To illustrate current liability entries, we use transaction information from Sierra Sports (see Figure 12.6). Sierra Sports owns and operates a sporting goods store in the Southwest specializing in sports apparel and equipment. The company engages in regular business activities with suppliers, creditors, customers, and employees. A company incurs expenses for running its business operations, and sometimes the cash available and operational resources to pay the bills are not enough to cover them.

2: Analyze, Journalize, and Report Current Liabilities

The same entry for interest will occur every three months until year-end. When accumulated interest is paid on January 1 of the following year, Sierra would record this entry. The $3,500 is recognized in Interest Payable (a credit) andInterest Expense (a debit).

A current liability arises each time an entity receives an economic benefit for which the payment is to be met within one year period or within an operating cycle (which ever is longer). The liability is journalized by crediting a liability account and debiting an asset or expense account depending on the nature or type of benefit received by the entity. Yes, notes payable are considered current liabilities reporting and analyzing current liabilities if they are due within one year. If the repayment period extends beyond 12 months, they are classified as long-term liabilities.

The plan includes a treatment in November 2019, February 2020, and April 2020. The company has a special rate of $120 if the client prepays the entire $120 before the November treatment. However, to simplify this example, we analyze the journal entries from one customer. Assume that the customer prepaid the service on October 15, 2019, and all three treatments occur on the first day of the month of service.

Note that Inventory is decreased in this entry because the valueof the merchandise (soccer equipment) is reduced. When applying theperpetual inventory method, this reduction is required by generallyaccepted accounting principles (GAAP) (under the cost principle) toreflect the actual cost of the merchandise. Note that Inventory is decreased in this entry because the value of the merchandise (soccer equipment) is reduced. When applying the perpetual inventory method, this reduction is required by generally accepted accounting principles (GAAP) (under the cost principle) to reflect the actual cost of the merchandise. GAAP (primarily ASC 210 and ASC 405) and IFRS (IAS 1 and IAS 37), including definitions, recognition criteria, common examples, and financial statement presentation.

• Common current liabilities include accounts payable, unearned revenues, the current portion of a note payable, and taxes payable.
• Options are worthless if the stock price on the vesting date is lower than the price at which they were granted.
• Interest is a monetary incentive to the lender, which justifies loan risk.
• The proper classification of liabilities as current assists decision-makers in determining the short-term and long-term cash needs of a company.

Accounts Payable decreases (debit) for the original amount due, Inventory decreases (credit) for the discount amount of $240 ($12,000 × 2%), and Cash decreases (credit) for the remaining balance due after discount. Current liabilities represent obligations that a company expects to settle within its normal operating cycle or within twelve months of the reporting date, whichever is longer. These obligations are a critical component of short-term liquidity analysis and working capital management.

On the other hand, consistently rising short-term obligations without corresponding growth in assets may indicate financial strain. Businesses can better manage cash flow by monitoring current liabilities, as knowing when payments are due, such as loans, taxes, or supplier invoices, helps ensure timely disbursements. Cash increases (debit) for the sales amount plus sales tax.Sales Tax Payable increases (credit) for the 6% tax rate ($18,000 ×6%). Salesincreases (credit) for the original amount of the sale, notincluding sales tax. If Sierra’s customer pays on credit, AccountsReceivable would increase (debit) for $19,080 rather than Cash.

The $3,500 is recognized in Interest Payable (a credit) and Interest Expense (a debit). When Sierra remits payment to the State Tax Board on October 1,the following entry occurs. After this transaction, Sierra still owed $11,000 and still had$11,000 in inventory from the purchase, assuming that Sierra hadnot sold any of it yet. When Sierra remits payment to the State Tax Board on October 1, the following entry occurs.

To demonstrate this concept, after buying $12,000 in inventory,returning $1,000 in inventory, and then paying for the remainingbalance and qualifying for the discount, Sierra’s Inventory balanceincreased by $10,780, as shown. Inthis case, Accounts Payable would increase (a credit) for the fullamount due. Inventory, the asset account, would increase (a debit)for the purchase price of the merchandise.

A similar typeof payment will be paid each year for as long as any of the notepayable remains; however, the annual interest expense would bereduced since the remaining note payable owed will be reduced bythe previous payments. Companies are wary of recording liabilities because of the negative impact on reported information. Thus, U.S. GAAP has established rules to help ensure the proper inclusion of liabilities. Current liabilities typically are those reported debts that must be satisfied within one year from the balance sheet date. Because a company needs to be able to meet its debts as they come due, analysts pay close attention to this total. The current ratio is also watched closely by many as a sign of financial strength.

Remember that since we are assuming that Sierra was using theperpetual inventory method, purchases, payments, and adjustments ingoods available for sale are reflected in the company’s Inventoryaccount. In our example, one of the potential adjustments is thatdiscounts received are recorded as reductions to the Inventoryaccount. Remember that since we are assuming that Sierra was using the perpetual inventory method, purchases, payments, and adjustments in goods available for sale are reflected in the company’s Inventory account.

In another scenario using the same cost information, assume that on April 3, the league contracted for the production of the uniforms on credit with terms 5/10, n/30. They signed a contract for the production of the uniforms, so an account receivable was created for Sierra, as shown. To demonstrate this concept, after buying $12,000 in inventory, returning $1,000 in inventory, and then paying for the remaining balance and qualifying for the discount, Sierra’s Inventory balance increased by $10,780, as shown.

For example, a bakery company may need to take out a $100,000 loan to continue business operations. Terms of the loan require equal annual principal repayments of $10,000 for the next ten years. Even though the overall $100,000 note payable is considered long term, the $10,000 required repayment during the company’s operating cycle is considered current (short term). This means $10,000 would be classified as the current portion of a noncurrent note payable, and the remaining $90,000 would remain a noncurrent note payable. Common current liabilities include accounts payable, unearned revenues, the current portion of a note payable, and taxes payable. Each of these liabilities is current because it results from a past business activity, with a disbursement or payment due within a period of less than a year.

Also, since the customer could request a refund before any of the services have been provided, we need to ensure that we do not recognize revenue until it has been earned. While it is nice to receive funding before you have performed the services, in essence, all you have received when you get the money is a liability (unearned service revenue), with the hope of it eventually becoming revenue. The following journal entries are built upon the client receiving all three treatments. First, for the prepayment of future services and for the revenue earned in 2019, the journal entries are shown.