Chapter 10 Current liabilities
Definitions A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. A current liability is a liability, which satisfies any of the following criteria: (a) it is expected to be settled in the entity’s normal operating cycle; (b) it is held primarily for the purpose of being traded; (c) it is due to be settled within 12 months after the financial statement date.
Examples • Bank finance. • Trade payables (creditors) (suppliers). • Unpaid expenses (‘accruals’). • Taxation.
Examples (Continued) • Bank finance – Overdraft, repayable on demand. • Trade payables (creditors) – Usually set conditions for repayment, for example, within 30 days or 60 days. May charge interest on overdue amounts. Problem of large organisations delaying payment to small suppliers. Companies are required to explain their policy in paying suppliers who have given credit.
Examples (Continued) Taxation:Companies pay taxes on profits after the profit is earned. Large companies pay quarterly, whereas others pay 9 months after the year-end. Both give current liability. Some tax payments can be delayed for a longer time – called ‘deferred taxation’.
Recognition Recognise if: (a) item meets the definition of a liability; (b) there is sufficient evidence that the liability has been created; and (c) that the item has a cost or value that can be measured with sufficient reliability.
Recognition (Continued) Risk of understatement (see chapter 4 on prudence) Understatement of liabilities will result in overstatement of the ownership interest.
Contingent liabilities Obligations that are contingent upon (depend upon) some future event happening. Examples are: • Continuing legal proceedings against the company, for example, product failure • Guarantees to bank on behalf of third party borrowing • Possible taxation penalties from a specific transaction undertaken.
Recording expenses • Matching concept: Match all expenses of the period against revenue, whether paid in cash or not. • Accruals concept: Record all known liabilities at the date of the financial statements.
Accrual of expenses A company starts business on 1 January Year 1. It has a financial year end of 31 December Year 1. During Year 1 it receives four accounts for electricity, all of which are paid ten days after receiving them. The dates of receiving and paying the accounts are as follows:
Analysis of transaction Table 10.1 Spreadsheet analysis of transactions relating to the expense of electricity consumed, Year 1
Summary of spreadsheet Asset – Liability = Ownership interest ¯ ¯ – £810 + £340 – £1,150
ASSET LIABILITY OWNERSHIP INTEREST: PROFIT Date Transactions Cash Electricity company Electricity expense 340 Dec 31 Accrual for three months (340) Summary of spreadsheet (Continued) What if the final electricity invoice for the year has not been received on 31 December Year 1? If no invoice has been received then there will be no entry in the accounting records. Spreadsheet entry for accrual Table 10.2 Spreadsheet entry for accrual at the end of the month
Chapter 10 Bookkeeping supplement
Analysis of debit and credit L1 Expense (electricity)
Analysis of debit and credit (Continued) L2 Liability to supplier
Analysis of debit and credit (Continued) L3 Accrual
Analysis of debit and credit (Continued) What happens when the invoice arrives? It creates a liability to the supplier and cancels the ‘accrual’ previously recorded.