Current Liabilities - Explained
What are Current Liabilities?
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Table of ContentsWhat are Current Liabilities?How are Current Liabilities Used? Examples of Current LiabilitiesAccounting for Current LiabilitiesBelow is an example of current liability
What are Current Liabilities?
A current liability refers to a debt that is due within 12 months, this type of debt or obligation must be repaid within a current period, which is often one year of its life cycle. Companies or individuals accrue debts or financial obligations that are expected to be repaid. The liability can be current or non-current. Current liabilities are due within one year, these liabilities are recorded on the company's balance sheet. Oftentimes, companies settle current liabilities through the use of cash (equity) or through the creation of a new current liability.
How are Current Liabilities Used?
Current liabilities exist in all companies, the ability of a company to settle its current liabilities is crucial, this determines whether the company is solvent or insolvent. There are two ways analysts examine the ability of a company to pay off its current liabilities, they are;
- Quick ratio: this is done by deducting the inventories of a company from its current assets and dividing by its current liabilities.
- Current ratio: this is the current assets of a company divided by its current liabilities.
Current liabilities as recorded on the balance sheet are accounts payable, short-term debts, accrued liabilities, and other similar debts.
Examples of Current Liabilities
The current liability account of a company depends on the amount of debts it owes or unpaid financial obligations. Oftentimes, the accounts payable of a firm generate current liabilities the most. Accounts payable include unpaid supplier invoices, debts for raw materials, fuel purchase, transportation and logistics, equipment and others. Supplier invoices is often the evidence for accounts payable. Debts or obligations that make up current liabilities are interest payable, payroll taxes payable, dividends payable, customer deposits, income taxes payable, sales taxes payable, current portion ofdeferred revenue, and accrued expenses.
Accounting for Current Liabilities
The accountant of a company is responsible for accounting for its current liabilities. Current liabilities are debts that companies must pay within a year. Also, it is important that a company's current asset is separated from its current liability.
Below is an example of current liability
If a technology company is supplied materials for manufactory phone gadgets worth $300,000 by a vendor, it is expected that the company settles the debt quickly or once the materials are used for production and sales realized from the production. This $300,000 that the company owes the vendor is recorded as accounts payable, which is a current liability. Once the company pays the vendor the debt owe, it reflects in its balance sheet, as the accounts payable is debited.
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