What are Current Liabilities: Example and Calculation

Introduction

Understanding a company’s financial health involves examining multiple parameters within the balance sheet, including current liabilities. These are short-term obligations that make up a significant portion of the general financing strategy and operational effectiveness of a business. Effective management of current liabilities ensures smooth financial operations and maintains liquidity for meeting short-term obligations. 

In this blog, we will understand why current liabilities are indispensable to the company’s capital structure. We shall cover examples of current liabilities, provide an in-depth guide on how one can calculate them, and much more.

What are Current Liabilities? 

Current liabilities are short-term financial obligations that a company must pay within one year or its operating cycle, whichever is longer. These liabilities arise from various business activities, including purchasing inventory on credit, taking short-term loans, or accruing expenses.

Current liabilities are very important for assessing a company’s liquidity and health. Here are a few important aspects related to it:

• Types

  Some common types include accounts payable, short-term loans, salaries payable, tax payable, accrued expenses, and deferred revenues.

• Importance

  Effective management of current liabilities will guarantee the ability to pay short-term obligations without affecting the cash flow of a company, and this will be important in maintaining operational efficiency and avoiding financial difficulties.

• Impact on financial statements

  Current liabilities will be presented on the balance sheet, and the amount will be helpful to determine liquidity ratios, for example, current ratio, quick ratios, and cash ratio which calculate the businesses ability to meet its short-term obligations.

• Example

  Real-life examples of current liabilities are money owed by a business to the suppliers for inventory purchased on credit or outstanding utility bills that are yet to be paid. 

How are Current Liabilities Generated? 

Current liabilities are a result of various daily business activities and financing. Such obligations can be a result of purchasing inventory on credit, accruing expenses, borrowing short-term loans, and making advance payments for goods and services. Understanding how current liabilities are generated will help the business manage them properly by providing plans for timely settlements that maintain financial stability. Let us look at a few sources of current liabilities:

• Purchase on credit

  Goods or services purchased on credit give rise to accounts payable, which is a common kind of current liability.

• Accrued expenses

  Expenses that are accrued, like salaries, utilities, and interest, are due and payable in a short period, resulting in accrued liabilities.

• Short-term borrowings

  Taking short-term loans or opening lines of credit generates short-term financial obligations that have to be repaid within a year.

• Deferred revenues

  It is the advance money received against goods or services that are to be delivered. This is a liability for the company as they need to deliver the goods or services.

Accounting for Current Liabilities

Accounting for current liabilities accurately provides a transparent financial overview of the company. It systematically identifies, measures, and records short-term obligations, ensuring all relevant liabilities are properly recorded in the books and accurately reflected in the financial statements.

The following are some key points to consider with regard to accounting for current liabilities:

• Identification

  Identify the liability when it was incurred. Make sure that all liabilities are captured and accounted for whenever they arise, providing a timely and accurate reflection of the present financial position of the company.

• Measurement

  Accurate measurement of the amount of liability is important in financial reporting and ensures that the financial statements reflect current and fair values.

• Journal entries

  Journal entries are required to account for the liability in the books of account. Proper recording of liabilities is essential to ensure that items are presented accurately in the balance sheet and other financial reports, ensuring financial information integrity. 

• Presentation

   The presentation of current liabilities should be separate from long-term liabilities on a balance sheet. This will help users understand the firm’s short-term debt obligations and the overall liquidity position.

Example of Current Liabilities 

To understand current liabilities better, let’s explore two detailed examples with journal entries that illustrate how these liabilities are recorded and managed in a business setting.

Example 1: Accounts payable 

A company, XYZ Corp, purchases $10,000 worth of inventory on credit from a supplier on January 10, 2024, with payment due in 30 days.

Journal Entry

When inventory is purchased on credit, XYZ Corp records the following journal entry to reflect the increase in inventory and the creation of an account payable.

This entry shows that the inventory account is debited, increasing the company’s assets, while accounts payable are credited, indicating a liability that XYZ Corp must settle within 30 days.

Payment Entry: When XYZ Corp pays the supplier on February 9, 2024, the following journal entry is made:

This entry shows the reduction in both the cash account (asset) and the accounts payable (liability), reflecting the payment made to settle the debt.

Example 2: Salaries payable 

At the end of October 2024, XYZ Corp accrues $5,000 in salaries payable for work performed by employees during the month, with payment to be made on the next payday.

Journal Entry
At the end of the month, XYZ Corp records the following journal entry to recognize the salary expense and the liability.

This entry shows that the salaries expense account is debited, increasing the company’s expenses, while salaries payable is credited, indicating a liability that XYZ Corp must pay in the near term.

Payment Entry: When XYZ Corp pays the salaries on the next payday, the following journal entry is made:

This entry shows the reduction in both the cash account (asset) and the salaries payable (liability), reflecting the payment made to settle the accrued salaries.

These examples illustrate how current liabilities are recorded and managed within a company’s accounting system. They highlight the importance of accurately tracking short-term obligations to ensure timely payments and maintain financial stability.

Real-life example of current liabilities 

Source

How to Calculate Current Liabilities 

While current liabilities are quite straight-forward to calculate, yet they should not be taken lightly.Calculating current liabilities involves identifying and adding up all the short-term obligations due within one year. Accurate recording of current liabilities enables businesses to gauge their short-term financial health and make provisions for funds to pay off such liabilities without impacting liquidity.

Let’s look at a few things to consider while calculating current liabilities:

• Identify all the current liabilities

  Note down every obligation that is due within one year. Ensure that no liabilities are overlooked.

• Determine the amounts

  All amounts should be accurate and updated. Verify and reconcile the amounts to understand what a company owes at a given point in time.

• Sum up the amounts

  Compute all the identified short-term obligations to get the total current liabilities. This provides a clear view of the financial obligations of a company. 

Example

Assume a company has the following current liabilities:

• Accounts Payable: $15,000
• Short-term Loans: $8,000
• Salaries Payable: $6,000
• Taxes Payable: $4,000

Calculation:
Total Current Liabilities = $15,000 + $8,000 + $6,000 + $4,000 = $33,000

Journal Entry:

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FAQs

1) Why do investors care about current liabilities?

Investors are concerned about current liabilities because they deal with the liquidity or short-term financial condition of the firm. High current liabilities may indicate that a company will have cash flow problems that would result in an inability to pay off its liabilities.

2) What are some current liabilities listed on a balance sheet?

The most common current liabilities that appear on the balance sheet include accounts payable, short-term loans, salaries payable, taxes payable, accrued expenses, and deferred revenue. All these reflect expenditures a company is bound to pay within a year or its operative cycle.

3) Is accumulated depreciation a current liability?

No, accumulated depreciation is not a current liability. It refers to the contra-asset accounts that reduce the value of fixed assets. Cumulative depreciation refers to the total amount of depreciation expensed against an asset in its lifetime and reduces its book value. 

4) Is deferred revenue a current liability?

Yes, deferred revenue is a current liability. It constitutes those advance payments a company receives from its customers for goods and services yet to be delivered. Since the firm owes the delivery of these goods or services, it is recorded as a liability until it’s discharged.

5) Are accounts payable current liabilities?

Yes, accounts payable are current liabilities. They represent amounts a company owes to suppliers for goods or services received on credit. Since these obligations are typically due within a year, they are classified as current liabilities on the balance sheet, reflecting short-term financial commitments.