The Meaning of Current Obligations
obligations that can be satisfied within a year (or the operational cycle, if longer) or that lead to the formation of new current obligations are considered current liabilities.
Short-Term vs. Long-Term Obligations
Liabilities on a balance sheet can be either “current” or “long-term,” depending on their expected duration.
Liabilities classed as current must either be liquidated through the use of current assets or converted into new current liabilities.
Accounts Payable, Short-Term Notes Payable, Current Maturities of Long-Term Debt (the principal part of a long-term liability due within the next 12 months), Taxes Payable, and other Accrued Payables are all examples of current liabilities.
Liabilities that cannot be paid off within a year or the business cycle, whichever is longer, are considered long-term. Mortgages, Bonds, and Lease Obligations are all included here.
However, the fraction of these long-term obligations that is due right now counts as a current liability, as previously mentioned.
Quantifying and Placing a Value on Immediate Obligations
Liabilities, like assets, are initially documented and accounted for based on the cost principle. That is, the expense is recorded at the time it is incurred based on the fair market value of the good or service that was provided.
Due to the short maturity of current liabilities, they are recorded at face value. To pay off the principal of the obligation, this sum of money is required.
The fact that these future monetary outlays have a lower present value is ignored. Value at present time is linked to the concept of discounting future cash flows.
Money received or paid in the future has less value than the same amount of money received or paid today due to the time value of money. This is due to the fact that liquid funds have higher potential for future growth through investment.
Therefore, the present value of the responsibility is less than the amount that will be paid to settle the obligation in the future.
Due to the short time frame between the time a responsibility is incurred and when it is paid, the difference between the value today and future cash expenditure is not substantial in connection with current liabilities.
Therefore, the amount of the next scheduled principal payment is reflected as a current liability.
Long-term liabilities, liabilities with no stated interest, and liabilities with a claimed interest rate that is significantly different from the market rate for identical transactions all require an application of present value concepts.
Varieties of Immediate Obligations
Commonly, three types of liabilities are recognized:
Those whose exact count can be calculated
Revenues owed to others and obligations dependent on business activity
Liabilities Where the Amount Is Clearly Known
A present liability is said to be “definitely determinable” if its size is both known and certain.
Accounts Payable, Trade Notes Payable, Current Maturities of Long-term Debt, Interest Payable, and Dividends Payable are all examples of items that fall under this heading.
Determining the existence of such liabilities and making sure they are reported during the correct accounting period are two of the biggest challenges in this area of accounting.
The cost of products sold and total liabilities will be underestimated, for instance, if the cost of an item is included in the closing inventory without a corresponding payable and/or purchase being recorded.
Accrued obligations including interest payable, salaries owed, and unearned income are also definite liabilities.
Accrued obligations must be recorded with periodic journal entries. Income is overstated while liabilities are understated when accrued obligations are ignored.
A company may be paid in advance for services or products it will eventually provide. This prepayment is a liability since the company now has an obligation to deliver the service or deliver the items.
Unearned revenues include things like deposits, prepaid rent, and subscriptions or dues paid in advance.
Since the delivery or performance of these obligations often occurs within a year or the operational cycle (if longer than a year), these debts are considered current. They should be considered non-current if this is not the case.
Obligations Representing Third-Party Collections or Pending Business Activity
Collections on behalf of third parties, such as labor unions or government agencies, are a common obligation for businesses.
For instance, in many nations, residents and/or businesses are subject to taxation, and some organizations are tasked with collecting that tax on the government’s behalf.
Sales and excise taxes, SS and withholding taxes, and union dues all fall under this heading. Some obligations, such as corporate income taxes paid to the federal government and state governments, are contingent on the success or failure of the business.
Current Liabilities as Shown on a Balance Sheet
The management decides the sequence in which current obligations are shown on the balance sheet.
Safeway Stores Inc.’s current liability section is representative of that which can be found in the financial statements of many American corporations.
This means that the order of the items listed is often notes and loans, accounts payable, and then accrued liabilities and taxes.