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Module 12, Ch. 12: Current Liabilities and Contingencies
*Note: this course skipped Chapter 11, Intangible Assets
12.1 Current Liabilities
Q. What is a liability?
- FASB says: “Probable future sacrifices of economic benefits arising from present obligations to transfer
assets or provide services to other entities in the future as a result of past transactions or events.”
- In simpler terms: Current resources we have that we must give up in the future to settle an obligation
that has been incurred from past activities.
Q. What are current liabilities and how are they typically settled?
- Current liabilities are “obligations whose liquidation is reasonably expected to require use of existing
resources properly classified as current assets, or the creation of other current liabilities.”
- In simpler terms: Current liabilities are debts or bills that a company expects to pay off within the next
year using the cash or other current assets it already has, or by taking on new short-term debts.
Q. What does the operating cycle represent?
- Period of time elapsing between the acquisition of goods and services and the final cash realization
resulting from sales and subsequent collections.
Q. What are the 5 common types of current liabilities?
1. Accounts payable
2. Notes payable (notes typically accrue interest while A/P does not)
3. Sales tax payable
4. Income taxes payable
5. Employee-related liabilities
Accounts Payable
Q. What are accounts payable (or trade accounts payable)?
- Balances owed to others for goods, supplies, or services purchased on open account.
Q. Why do accounts payable exist?
- There is a time lag between the receipt of services or acquisition of title to assets and the payment for
them.
Example: Assume that Target purchases $800,000 of merchandise from Clorox to sell in its stores, terms
2/10, net 30. What is the entry that Target should make to record the purchase of these goods, assuming it
uses the perpetual inventory system?
Inventory 800,000
, 2
Accounts Payable 800,000
Notes Payable
Q. What are notes payable?
- Written promises to pay a certain sum of money on a specified future date.
Q. What are the 2 classifications of notes payable (in terms of timing)?
- Short-term or long-term.
Q. What are the 2 classifications of notes payable (in terms of interest)?
- Interest-bearing or zero-interest-bearing.
Q. What do notes payable arise from?
- Purchases, financing, or other transactions.
Example of an interest-bearing note: Assume that Wells Fargo agrees to lend $100,000 to EatStreet on
March 1, 2025, if EatStreet signs a $100,000, 6%, 4-month note. Thus, the principal and interest on the note
would be due July 1, 2025. What is the entry to record issuance of the note?
March 1 Cash 100,000
Notes Payable 100,000
If EatStreet prepares financial statements semiannually, it makes the following adjusting entry to recognize
interest expense and interest payable of $2,000 at June 30. The 2,000 comes from (100,000 x 6% x 4/12).
June 30 Interest Expense 2,000
Interest Payable 2,000
At maturity, EatStreet must pay the face value of the note ($100,000) plus $2,000 interest. EatStreet records
payment of the note and accrued interest as follows. (You need to remove the notes payable and interest
payable).
July 1 Notes Payable 100,000
Interest Payable 2,000
Cash 102,000
Example of a NON interest-bearing note: Assume that EatStreet issues a $102,000, 4-month, zero-interest
bearing note to Wells Fargo. The present value of the note is 100,000. The bank discount rate used in this
example to find the present value is 5.96%.
March 1 Cash 100,000
Discount on Notes Payable 2,000
, 3
Notes Payable 102,000
How would this appear on the balance sheet?
Current liabilities
Notes payable $102,000
Less: Discount on notes payable 2,000 $100,000
Q. What type of account is Discount on Notes Payable?
- It is a contra liability account (it reduces the carrying value of notes payable) so it has a DEBIT balance.
Q. How is the discount amortized over time?
- Debit: Interest Expense
- Credit: Discount on Notes Payable
Summary of notes payable vs notes receivable
Notes Payable Notes Receivable
You are the… Borrower Lender
Discount means You received less cash than face value You gave less cash than face value
Why discount? Stated rate < market rate Stated rate < market rate
The discount is… Debited to Interest Expense Credited to Interest Revenue
Discount amortized = Interest Expense − Cash Interest paid Interest Revenue – Cash interest received
Unamortized discount Decreases each period Decreases each period
Carrying value Increases each period Increases each period
Sales tax payable
Q. What is sales tax payable?
- Sales taxes collected from customers on transfers of tangible personal property and on certain
services, which are then remitted to the proper governmental authority.
Example of sales tax payable: Prepare the entry to record sales taxes assuming there was a sale of $3,000
when a 4% sales tax is in effect.
Cash 3,120
Sales Revenue 3,000
Sales Tax Payable 120
, 4
Many companies do not separate the sales tax and the amount of the sale at the time of sale. Instead, the
company credits both amounts in the Sales Revenue account. Assume that Marshal Co.’s sales revenue
account balance of $150,000 includes sales taxes of 4%. Prepare the entries to record the revenue and the
sales taxes payable.
Suppose the amount of revenue is R
R + 0.04R = 150,000
1.04R = 150,000
R = 144,230.77 and sales tax liability = 150,000 – 144,230.77 = 5,769.23
Accounts Receivable 150,000
Sales Revenue 150,000
Sales Revenue 5,769.23
Sales Taxes Payable 5,769.23
Income tax payable
Q. How often do corporations make tax payments?
- They must make tax payments periodically; income tax payable is a current liability.
Q. Why are there sometimes differences between taxable income (tax laws) and accounting income (GAAP)?
- Differences exist because GAAP is focused on economic substance, while tax law is focused on rules
and tax policy.
Q. What are deferred taxes?
- Deferred taxes arise because accounting rules (GAAP) and tax rules (IRS) often tell you to recognize
income and expenses at different times.
- They appear on the balance sheet as either:
- Deferred Tax Asset (DTA): Future tax savings
- Deferred Tax Liability (DTL): Future tax payments
Example of income taxes payable: Margo Company reports taxable income of $300,000, and its tax rate is
20%.
Income Tax Expense 60,000
Income Taxes Payable 60,000
The income taxes payable will be remitted to the government throughout the year, usually on a quarterly
basis.
Employee-related liabilities
Module 12, Ch. 12: Current Liabilities and Contingencies
*Note: this course skipped Chapter 11, Intangible Assets
12.1 Current Liabilities
Q. What is a liability?
- FASB says: “Probable future sacrifices of economic benefits arising from present obligations to transfer
assets or provide services to other entities in the future as a result of past transactions or events.”
- In simpler terms: Current resources we have that we must give up in the future to settle an obligation
that has been incurred from past activities.
Q. What are current liabilities and how are they typically settled?
- Current liabilities are “obligations whose liquidation is reasonably expected to require use of existing
resources properly classified as current assets, or the creation of other current liabilities.”
- In simpler terms: Current liabilities are debts or bills that a company expects to pay off within the next
year using the cash or other current assets it already has, or by taking on new short-term debts.
Q. What does the operating cycle represent?
- Period of time elapsing between the acquisition of goods and services and the final cash realization
resulting from sales and subsequent collections.
Q. What are the 5 common types of current liabilities?
1. Accounts payable
2. Notes payable (notes typically accrue interest while A/P does not)
3. Sales tax payable
4. Income taxes payable
5. Employee-related liabilities
Accounts Payable
Q. What are accounts payable (or trade accounts payable)?
- Balances owed to others for goods, supplies, or services purchased on open account.
Q. Why do accounts payable exist?
- There is a time lag between the receipt of services or acquisition of title to assets and the payment for
them.
Example: Assume that Target purchases $800,000 of merchandise from Clorox to sell in its stores, terms
2/10, net 30. What is the entry that Target should make to record the purchase of these goods, assuming it
uses the perpetual inventory system?
Inventory 800,000
, 2
Accounts Payable 800,000
Notes Payable
Q. What are notes payable?
- Written promises to pay a certain sum of money on a specified future date.
Q. What are the 2 classifications of notes payable (in terms of timing)?
- Short-term or long-term.
Q. What are the 2 classifications of notes payable (in terms of interest)?
- Interest-bearing or zero-interest-bearing.
Q. What do notes payable arise from?
- Purchases, financing, or other transactions.
Example of an interest-bearing note: Assume that Wells Fargo agrees to lend $100,000 to EatStreet on
March 1, 2025, if EatStreet signs a $100,000, 6%, 4-month note. Thus, the principal and interest on the note
would be due July 1, 2025. What is the entry to record issuance of the note?
March 1 Cash 100,000
Notes Payable 100,000
If EatStreet prepares financial statements semiannually, it makes the following adjusting entry to recognize
interest expense and interest payable of $2,000 at June 30. The 2,000 comes from (100,000 x 6% x 4/12).
June 30 Interest Expense 2,000
Interest Payable 2,000
At maturity, EatStreet must pay the face value of the note ($100,000) plus $2,000 interest. EatStreet records
payment of the note and accrued interest as follows. (You need to remove the notes payable and interest
payable).
July 1 Notes Payable 100,000
Interest Payable 2,000
Cash 102,000
Example of a NON interest-bearing note: Assume that EatStreet issues a $102,000, 4-month, zero-interest
bearing note to Wells Fargo. The present value of the note is 100,000. The bank discount rate used in this
example to find the present value is 5.96%.
March 1 Cash 100,000
Discount on Notes Payable 2,000
, 3
Notes Payable 102,000
How would this appear on the balance sheet?
Current liabilities
Notes payable $102,000
Less: Discount on notes payable 2,000 $100,000
Q. What type of account is Discount on Notes Payable?
- It is a contra liability account (it reduces the carrying value of notes payable) so it has a DEBIT balance.
Q. How is the discount amortized over time?
- Debit: Interest Expense
- Credit: Discount on Notes Payable
Summary of notes payable vs notes receivable
Notes Payable Notes Receivable
You are the… Borrower Lender
Discount means You received less cash than face value You gave less cash than face value
Why discount? Stated rate < market rate Stated rate < market rate
The discount is… Debited to Interest Expense Credited to Interest Revenue
Discount amortized = Interest Expense − Cash Interest paid Interest Revenue – Cash interest received
Unamortized discount Decreases each period Decreases each period
Carrying value Increases each period Increases each period
Sales tax payable
Q. What is sales tax payable?
- Sales taxes collected from customers on transfers of tangible personal property and on certain
services, which are then remitted to the proper governmental authority.
Example of sales tax payable: Prepare the entry to record sales taxes assuming there was a sale of $3,000
when a 4% sales tax is in effect.
Cash 3,120
Sales Revenue 3,000
Sales Tax Payable 120
, 4
Many companies do not separate the sales tax and the amount of the sale at the time of sale. Instead, the
company credits both amounts in the Sales Revenue account. Assume that Marshal Co.’s sales revenue
account balance of $150,000 includes sales taxes of 4%. Prepare the entries to record the revenue and the
sales taxes payable.
Suppose the amount of revenue is R
R + 0.04R = 150,000
1.04R = 150,000
R = 144,230.77 and sales tax liability = 150,000 – 144,230.77 = 5,769.23
Accounts Receivable 150,000
Sales Revenue 150,000
Sales Revenue 5,769.23
Sales Taxes Payable 5,769.23
Income tax payable
Q. How often do corporations make tax payments?
- They must make tax payments periodically; income tax payable is a current liability.
Q. Why are there sometimes differences between taxable income (tax laws) and accounting income (GAAP)?
- Differences exist because GAAP is focused on economic substance, while tax law is focused on rules
and tax policy.
Q. What are deferred taxes?
- Deferred taxes arise because accounting rules (GAAP) and tax rules (IRS) often tell you to recognize
income and expenses at different times.
- They appear on the balance sheet as either:
- Deferred Tax Asset (DTA): Future tax savings
- Deferred Tax Liability (DTL): Future tax payments
Example of income taxes payable: Margo Company reports taxable income of $300,000, and its tax rate is
20%.
Income Tax Expense 60,000
Income Taxes Payable 60,000
The income taxes payable will be remitted to the government throughout the year, usually on a quarterly
basis.
Employee-related liabilities
