Current Liabilities – Definition
Current liabilities are those liabilities that will either be paid or require the use of current assets within a year (or within the operating cycle, if longer), or that result in the creation of new current liabilities.
Current vs Long-term Liabilities
In preparing a balance sheet, liabilities are classified as either current or long-term.
Current liabilities require the use of existing resources that are classified as current assets or require the creation of new current liabilities. Current liabilities include such accounts as Accounts Payable, Short-term Notes Payable, Current Maturities of Long-term Debt (the principal portion of a long-term liability due within the next 12 months), Taxes Payable, and other Accrued Payables.
Long-term liabilities are those liabilities that will not be satisfied within one year or the operating cycle, if longer than one year. Included in this category are Mortgages Payable, Bonds Payable, and Lease Obligations. As noted, however, the current portion, if any, of these long-term liabilities is classified as current liabilities.
Measurement and Valuation of Current Liabilities
Like assets, liabilities are originally measured and recorded according to the cost principle. That is, when incurred, the liability is measured and recorded at the current market value of the asset or service received. Because current liabilities are payable within a relatively short period of time, they are recorded at their face value, which is the amount of cash needed to discharge the principal of the liability.
No recognition is given to the fact that the present value of these future cash outlays is less. The present value is related to the idea of the time value of money. Essentially it means that cash received or paid in the future is worth less than the same amount of cash received or paid today. This is because cash on hand today can be invested and thus can grow to a greater future amount. Thus, the value of the liability at the time incurred is actually less than the cash required to be paid in the future.
In connection with current liabilities, the difference between value today and future cash outlay is not material because of the short time span between the time the liability is incurred and when it is paid. Current liabilities, therefore, are shown at the amount of the future principal payment. However, present value concepts are applied to long-term liabilities, liabilities with no stated interest, and liabilities with a stated interest rate materially different from the market rate for similar transactions.
Types of Current Liabilities
Liabilities are often divided into three categories, (1) those that are definitely determinable in amount, (2) collections for third parties and those liabilities conditioned on operations, and (3) contingent liabilities.
Liabilities that are Definitely Determinable
Definitely determinable current liabilities are those liabilities that are known and are definite in amount. Included in this category are accounts such as Accounts Payable, Trade Notes Payable, Current Maturities of Long-term Debt, Interest Payable, and Dividends Payable. The major accounting problems associated with these liabüities are determining their existence and ensuring that they are recorded in the proper accounting period. For example, if the cost of an item is included in the ending inventory but a corresponding payable and/or purchase is not recorded, there will be an understatement of both cost of goods sold and total liabilities.
Other definitely determinable liabilities include accrued liabilities such as interest and wages payable and unearned revenues. Recognition of accrued liabilities requires periodic adjusting entries. Failure to recognize accrued liabilities overstates income and understates liabilities.
A firm may receive cash in advance of performing some service or providing some goods. Because the firm has an obligation to perform the service or provide the goods, this advance payment is a liability. These advance payments are called unearned revenues and include such items as subscriptions or dues received in advance, prepaid rent, and deposits. These liabilities are generally classified as current because the goods or services are usually delivered or performed within one year or the operating cycle, if longer than one year. If this is not the case, they should be classified as non-current liabilities.
Liabilities That Represent Collections for Third Parties or Are Conditioned on Operations
Firms are often required to make collections for third parties such as unions and governmental agencies. For example, taxes are levied on the consumer and/or the firm, and the firm is required to collect the tax on behalf of the taxing agency. Included in this category are sales and excise taxes, social security taxes, withholding taxes, and union dues. Other liabilities such as federal and state corporate income taxes are conditioned or based on the results of the enterprise’s operations.
Balance Sheet Presentation of Current Liabilities
The particular order in which current liabilities are presented on the balance sheet is a
management decision. The current liability section of Safeway Stores; Inc. is typical of those found in the balance sheets of many U.S. companies. That is, notes and loans are usually listed first, then accounts payable, and finally accrued liabilities and taxes.