Module 7: Current Liabilities What is a liability? – “Probable future sacrifice of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” – Future sacrifice of economic benefits. – Present obligations. – Past transactions or events. 1

Classification of Current Liabilities – expected to require the use of current assets (or the creation of other current liabilities) to settle the obligation. Valuing current liabilities on the balance sheet – Ignore present value – Report at face value Reporting current liabilities – Primary problem is ensuring that all existing current liabilities are reported on the balance sheet. 2

Current Operating Liabilities 1.Accounts payable - for purchase of goods and services (usually no interest). 2. Accrued liabilities - short-term payables usually settled with cash in the near future. Ex: Wages, Interest, Income Tax, Utilities, Vacation Pay, Bonuses, Property Taxes. 3. Unearned revenues – cash received before delivery of goods or service. Liability settled on delivery of goods and services. Ex: 1-year magazine subscription, club fees 4. Contingent liabilities – record when both probable and estimable. If less than probable or cannot estimate amount, then disclose in footnotes. Examples: warranties & lawsuits 3

Warranties 5.Companies generate sales revenue when they sell products; offering warranties is part of the cost of selling the product; the amount of the future warranty costs is not known, but may be estimated. – Record estimated expense and liability when products are sold (matching concept): Warranty Expensexx Estimated Warranty Liabilityxx – As costs are incurred (usually in subsequent periods), charge expenditure to warranty liability: Estimated Warranty Liabilityxx Cash, etc.xx Note: warranties, like other estimates, may be subject to manipulation. 4

Lawsuits 6. What about lawsuits where the company is the defendant? Should we accrue for the possible future liability? Only if the settlement is “probable” and “reasonably estimable”. Since the criteria are vague, and legal staff can usually find sufficient evidence to indicate a level of probability that the defendant will prevail or that settlement cannot be estimated, lawsuits are rarely recorded. Most lawsuits meet the minimum requirement of “reasonably possible” and must be disclosed in the notes to the financials; these disclosures inform investors as to the potential exposure. 5

Current Non-Operating Liabilities 7.Short-Term Interest-Bearing Debt - borrowing from bank is a financing activity, and not part of operations. 8.Current Portion of Long-Term Debt - the portion of long-term liabilities, like bonds and mortgages, that will come due within the next 12 months (as of the financial statement date), will require the use of current assets (specifically cash) to settle the liabilities; these liabilities must be classified as current liabilities. 6