Current Liabilities

Current liabilities are short-term obligations that usually must be paid from current assets within a year. These liabilities are a critical link in the operating cycles of most firms. In the course of day-to-day operations, firms incur short-term obligations to suppliers, employees, and other entities. The cash received from sales of goods and services to customers is then used to pay these obligations as they are due.

Current liabilities can be of several types: (1) obligations to pay cash to other entities, such as accounts payable, notes payable, and accrued liabilities; (2) obligations to provide other entities with goods or services for which payment has already been received, such as revenues received in advance; and (3) obligations to honor product warranties (guarantees). Examples of each are discussed next.

A lthough some current liabilities, such as accounts payable, are recorded when a company makes a purchase, others accrue during an accounting period and are not recorded until adjusting entries are made at the end of the period. In addition, the value of some accruals must be estimated. If accrued liabilities are not recognized and valued properly, both liabilities and expenses will be understated on the financial statements, making the company’s performance look better than it actually is.

Current liabilities require careful management of liquidity and cash flows, as well as close monitoring of accounts payable. In reporting on current liabilities, managers must understand how they should be recognized, valued, classified, and disclosed.

Chapters “Current Assets,” and “Noncurrent Assets,” discussed accounting and reporting for assets. Our focus now shifts to the sources of the funds that are invested in assets. The balance sheet equation indicates that the firm’s economic resources or assets are obtained from two sources: creditors and investors.

This chapter Current Liabilities and Chapter “Noncurrent Liabilities,” examine liability accounting and reporting issues. Chapter “Shareholders’Equity,” discusses shareholders’ equity. Liabilities or “borrowed capital” constitute a major source of funds for business firms. In fact, the average corporation relies on debt for more than half the funds it has invested in assets. The extent to which firms rely on debt financing depends upon the relative costs of issuing debt or equity securities. These relative costs differ across industries, and consequently the typical percentages of debt financing also vary across industries. In some industries (such as public utilities and financial institutions), debt financing can exceed 90 percent of total assets. Financial statement users pay careful attention to the sources of financing because the success of a firm depends as much on the effective management of its liabilities and shareholders’ equity as it does on the efficient utilization of its assets. The firm’s liability management also affects the risks and the returns available to the firm’s creditors and shareholders.

At the end of this chapter

  1. Recognize the types of current liabilities reported on the balance sheets of most business firms.
  2. Understand the types of business transactions and events that create current liabilities.
  3. Appreciate how liability reporting often depends on estimates and judgments.
  4. Be alert to a variety of other potential liabilities and risks that are not presently reported in the balance sheet.

Current Liabilities Contents

Managing Liquidity and Cash Flows

Types of Current Liabilities

Commitments, Contingencies and Risks

Off Balance Sheet Risks

 

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