Liabilities and stockholders’ equity support a company’s investment in assets. Liabilities must be recognized on the date they were incurred. Liabilities, much like assets, can be classified according to when they will be satisfied. “Current or short-term liabilities” are obligations that will be satisfied in the upcoming year; “Non-current liabilities” will be settled at some point beyond the current period. In general, balance sheet reports a number of current liabilities:
- Accounts payable
- Accrued salaries payable and related expenses
- Sales taxes payable
- Other accrued expenses
- Income taxes payable
- Current installments of long-term debt
Now, let’s go into the details….
“Accounts payable“, also known as “trade accounts payable“, represent amounts owed to other companies as a result of goods, services, materials, supplies, and so on acquired throughout the year. Conventional payment terms might require satisfaction of these obligations within 30 to 90 days of the invoice date, depending company’s relationship with the vendor.
Accrued Salaries Payable And Related Expenses
The recognition of accrued salaries and related expenses results from the application of accrual basis accounting. “Accrual accounting” requires revenues to be recognized when earned and expenses when incurred. The actual receipt of or payment with cash is not essential to the recognition of revenues and expenses in the accounting records. The key issue is whether product sales have occurred and what costs or expenses relate to the sale. Salaries are accrued because they are an expense that relates to the generation of revenue in the current period.
When an accrual takes place, it is often related to a transaction that does not coincide with the close of the fiscal year or the exact amount is not yet known (in the case of a contingent liability). For example: Royal Bali Cemerlang may distribute compensation to a certain group of employees on a weekly basis and others twice a month, on the 10th and 25th. Because the distribution of wage does not cover services provided by employees through the close of the fiscal year, an accrued liability for wages earned between the last payment date and the end of the year must be reported in the balance sheet.
The amount reported on the accrued salaries payable would also include payroll taxes that the company is responsible for and would include. This amount was computed at the close of the business year and recorded via a “year-end adjusting entry“.
Sales Taxes Payable
National & local tax authority mandates require corporations to collect sales tax when sales of tangible personal property are executed. Upon receipt from its customers, corporations have a legal obligation to remit these taxes to an appropriate government agency. Sales taxes are remitted periodically (usualy on monthly basis); therefore, any amounts collected represent a liability for the company collecting them.
Sales Tax Payable is classified as a current liability because satisfaction of this obligation will take place in the following month or quarter the longest.
Other Accrued Expenses
Other accrued expenses can include a variety of obligations. For example: this may include interest accrued on the company’s notes payable. Because the interest payment date does not fall at the end of the company’s fiscal year, there must be an accrual of interest from the last interest payment date through the end of the fiscal year. The company has additional obligations in the form of leases and installment notes that would require similar accounting accruals.
Accrued expenses can also include estimated liabilities that will be settled in the upcoming year. This could include: property tax expense that has been assessed for the current year but will be paid in the upcoming year, a litigation loss that has been accrued for but not yet settled, or bonuses that have been earned by key executives but will be paid in the upcoming quarter. Revenues received in advance (unearned revenue), such as deposits for goods ordered by the company, would also be recognized as a current liability.
Income Taxes Payable
Income taxes payable represents an estimated liability that is generally satisfied with periodic payments by the corporation to several taxing authorities. Income tax payments are based on an estimate of corporate pre-tax income. As estimates change with the passage of time, so will the periodic installments paid by the firm. Any estimated liability should be reported at the close of the fiscal year.
To understand what constitutes “pre-tax income (income tax installment)“, one must first understand the difference between before tax financial reported income (income statement) and pre-tax income (tax return). Revenues and expenses for tax purposes are determined in accordance with the rules set forth by the tax authority.
Revenues and expenses for financial reporting purposes are based on generally accepted accounting principles (GAAP). The result can be a significantly different income measure depending on which set of rules is applied. Because of this, companies generally report future tax liabilities and/or assets. Any income tax obligation (benefit) due in the following year is reported as a current liability (asset).
Current Installments Of Long-Term Debt
The final item shown under current liabilities involves components of long-term debt that are due in the upcoming period. This is typically referred to as the current maturities of long-term debt and may include obligations such as installment notes, mortgages, leases, and bond issues.
Upon review of a company’s financial statements, we may notice it has issued “commercial paper” that bears a certain average interest. Commercial paper generally represents short-term debt.
Read also part of this “Classification and Element Of Balance Sheet” post series are: