ACCOUNTING FOR SHORT TERM (CURRENT) LIABILITIES

Current (short term) liabilities are defined as obligations whose liquidation is reasonably
expected to require the use of existing resources properly classifiable as current assets, or
the creation of other current liabilities.
Current liabilities are obligations that must be paid within one year or within the operating
cycle, whichever is longer. Another requirement for classification as a current liability is the
expectation that the debt will be paid from current assets (or through the rendering of
services). Liabilities that do not meet these conditions are classified as long-term liabilities.
The time period used in defining current assets parallel’s that used in defining current
liabilities.
The amount of working capital (current assets-current liabilities) and the current ratio
(current assets divided by current liabilities) are valuable indicators of the company’s ability
to pay its debts in the near future.
Among the most common examples of current liabilities are accounts payable, short term
notes payable, accrued liabilities and unearned revenue.
Accounts Payable
Accounts payable – better described as trade accounts payable- is a designation reserved for
recurring trade obligations. These obligations arise from the firm’s ongoing operations
including the acquisition of stock, materials, supplies and services used in the production
and sale of goods or services.
Accounts payable arise because of the time lag between the receipt of services or
acquisition of title to assets and the payment for them. Most accounting systems are
designed to record liabilities for purchases of goods when the goods are received or
practically when the invoices are received. Frequently there is some delay in recording the
goods and the related liability on the books.
Short term notes payable
Short-term notes payable or just notes payable are issued whenever bank loans are
obtained. Other transactions that may give rise to notes payable include the purchase of
real estate or costly equipment, the purchase of merchandise and the substitution of a note
for a past-due account payable. Notes payable usually require the borrower to pay an
interest charge. Normally, the interest rate is stated separately from the principal amount of
the note. Notes payable are either secured by a mortgage or another type of lien that
specifies particular assets pledged as security or it is unsecured, if repayment is based only
on the general credit worthiness of the debtor.
A note payable may be designated as either interest bearing or non interest bearing also
known as zero interest bearing notes. An interest bearing note explicitly states a rate of
interest. This rate is called the stated rate of interest. Notes designated as non interest
bearing do not bear an explicit interest rate but instead implicitly reflect a rate of interest
called the effective rate, or yield. In other words, regardless of designation, all commercial
debt instruments implicitly or explicitly require the debtor to pay interest .This is because
the cost of using money over time cannot be avoided.
Interest Bearing Notes
Interest bearing notes specify a stated rate of interest on the face of the note. For an
interest bearing note, the debtor receives cash, other assets or services and pays back the
face amount of the note plus interest at the stated rate on one or more interest dates.
To illustrate an interest-bearing note, assume that on October 1, 2021, Madison Company
borrowed shs. 100,000 cash on a one year note with 12% interest payable at the maturity
date. Madison Company received cash equal to the face amount of the note shs. 100,000.
The accounting year ends 31 December and the maturity date of the note is 30 September
2022. This transaction requires the following accounting and reporting.
Entries during 2021
1 October 2021
Cash 100,000
Note payable 100,000
To record the interest bearing note at its present value
31 December 2021
Interest expense (100,000) (0.12) (3/12) 3,000
Interest payable 3,000
Adjusting entry for accrued interest expense
Reporting at 31 December 2021- Interest bearing note payable
Profit & Loss Account Shs.
Interest Expense 3,000

Balance Sheet Shs.

Current liabilities
Note payable 100,000
Interest payable 3,000
Entry at Maturity date:
30 September 2022
Interest payable 3,000
Interest expense (100,000) (0.12) (9/12) 9,000
Note payable 100,000
Cash 112,000
Payment of face amount of note payable plus interest at maturity

Non Interest (Zero Interest) Bearing Notes

Non –interest bearing is not a good descriptive designation for this type of note because
such notes do in fact bear interest. The face amount of this type of note includes both the
amount borrowed and interest as a single amount to be paid back at the maturity date. The
borrower receives the difference between the face amount and the interest on the note.
The cash to be received is the discounted value of the face amount using the effective
interest rate. The difference between the discounted cash value and the face amount of the
note is the interest. The effective interest rate is determined by reference to market rates
for instruments of similar risk. The effective rate is not specified on the note; however, it can
be determined. A non interest bearing note is also called a discounted note because the
cash received is less than the face amount of the note.
Consider an example.
Bingwa Company signed a shs. 112,000, one-year, non- interest-bearing note on 1 st Oct 2021
but received only shs. 100,000 cash. Since Bingwa Company received only shs. 100,000 cash,
the effective interest rate is 12% ( shs. 12,000/ shs. 100,000). The present value of this note
is shs. 100,000; that is, shs. 112,000 (PV1, 12%, 1) = shs 112,000 (0.89286)
= shs 100,000
Accounting entries and reporting
During 2021:
1 October 2021
Cash 100,000
Discount on note payable 12,000
Note payable 112,000
To record a non interest bearing note payable at its face amount.

31 December 2021
Interest expense (12,000) (3/12) 3,000
Discount on note payable 3,000
Adjusting entry for accrued interest at financial year end
31 December 2021
Profit & loss A/C Shs
Interest expense 3,000

Balance sheet Shs Shs

Current Liabilities
Note payable 112,000
Less: Unamortized discount 9,000 103,000

At maturity date:
30 September 2022
Interest expense (shs 12,000) (9/12) 9,000
Note payable 112,000
Discount on note payable 9,000
Cash 112,000
Payment of the face amount of the note

Class example
On 1 January 2021, a heavy-duty truck was purchased with a list price of sh. 335,000.
Payment included cash, shs. 85,000 and a two year non interest bearing note of shs.
250,000 (maturity date, 31 December 2022). The accounting period ends 31 December.
Assume that this note is a current liability and that the debtor received shs. 225,000.
Give all entries for each case from purchase date through maturity date of the note. Round
to the nearest shilling.
Accounting entries and reporting during 2021
Workings
Effective interest rate= 1 . 25,000 = 5½%
2 225,000
The present value of this note is shs. 225,000 that is
Shs. 250,000 (PV1, 5 ½%, 2) = 250,000 (0.89845)
= 225,000
Accounting entries and reporting
During 2021
1 January 2021
Cash 225,000
Discount on note payable 25,000
Note payable 250,000
To record a non interest bearing note payable at its face amount

31 December 2021
Interest expense (25,000) ( ½ ) 12,500
Discount on note payable 12,500
Adjusting entry for accrued interest

31 December 2021
Profit & loss A/C Shs
Interest expense 12,500

Balance sheet Shs Shs

Current Liabilities
Note payable 250,000
Less: Unamortized discount 12,500 237,500

At maturity date:
31 December 2022
Interest expense (shs 25,000) (1/2) 12,500
Note payable 250,000
Discount on note payable 12,500
Cash 250,000
Payment of the face amount of the note

Discount on Notes Payable

A contra liability account arising when the proceeds of a note payable is less than the face
amount of the note. The debit balance in this account will be amortized to interest expense
over the life of the note.
Amortization
Usually refers to spreading an intangible assets cost over that assets useful life with each
portion being recorded as an expense on the company’s income statement. It also refers to
paying off of debts in regular installments over a period of time.
Dividends Payable
After declaration by the board of directors, cash dividends, payable should be reported as a
current liability if they are to be paid within the coming year or operating cycle, whichever is
longer. Cash and property dividends payable are reported as a liability between the date of
declaration and payment on the legal basis that declaration gives rise to an enforceable
contract.
Liabilities are not recognized for undeclared dividends in arrears on preferred stock or for
any other dividends not formally declared by the Board of Directors.
Nevertheless, the amount of cumulative dividends unpaid should be disclosed in a note in
the financial statements or it may be shown in parentheses in the capital stock section of
the financial statements.
Dividends, payable in the form of additional shares of stock are not recognized as a liability.
Such stock dividends do not require future outlays of assets or services and are revocable by
the board of directors at any time prior to issuance.
Even so, such undistributed stock dividends are generally reported in the stock holder’s
equity section of the financial statements because they represent retained earnings in the
process of transfer to paid-in capital.
Scrip dividends payable are reported as a current liability unless there is no intention to
make payment in the next fiscal (financial) year. A dividend payable in scrip is a promise by
the cooperation to pay the dividend at a later date. Scrip dividends are declared when the
corporation wishes to keep its record of continuous dividend payments uninterrupted, has
the necessary retained earning to legally declare the dividend but is currently short of cash.
Dividends payable and notes payable are examples of definitely determinable liabilities
because their timing and amount is known.
Accrued Liabilities
Accrued liabilities include wages earned by employees and interest earned by creditors but
not as yet paid. Accrued liabilities are recorded in the accounts by making adjusting entries
at the end of the accounting period. For example, any wages that have not yet been
recorded or paid at the end of the accounting period must be recorded by debiting wage
expenses and crediting wages payable. Recognition of accrued liabilities is consistent with
the definition of a liability and the matching principle.
Unearned Revenues (Revenues Collected in Advance)
Cash collected in advance of the delivery of a good or service creates a liability. The
transaction does not yet qualify for recognition as revenue in conformity with the revenue
principle. Examples of revenue collected in advance include gift certificates, college tuition,
rent, ticket sales and magazine subscriptions. Such transactions are recorded as a debit to
cash and a credit to an appropriately designated current liability account. This account is
often titled unearned revenues and may be given a modifying adjective, for example,
unearned subscriptions revenue in the case of subscriptions. Other titles, for this account
include prepaid subscriptions revenue and subscriptions revenue collected in advance.
Subsequently, when the product or service is delivered and the revenue earned, the liability
account is decreased and the appropriate revenue account is credited.
To illustrate, on November 1, 2021 Ellis Company collected rent of shs 60,000 for the next
six months. The accounting period ends December 31. The entries are.
November 1 2021
Shs. Shs.
Cash 60,000
Rent revenue collected in advance 60,000
(or unearned rent revenue)
To record rent collected in advance

December 31, 2021

Rent revenue collected in advance 20,000
(or unearned rent revenue)
Rent revenue (60,000) (2/6) 20,000
Adjusting entry for the portion of rent earned.
The remaining prepaid rent revenue of shs. 40,000 is reported as a current liability because
Ellis has an obligation to render future occupancy services during the following four months.