 Hello and welcome to the session in which we would look at current liabilities. This is part one of four sessions that I will be discussing this topic. What are current liabilities? What's the big idea? Well, current liabilities are current obligation, liabilities are obligation or simply put a debt that are due means they need to be settled within the next 12 month or the company operating cycle by using current assets or creating another current liabilities. That's a mouthful. Let's break down the definition of current liabilities and examine each component separately to make sure we understand the big idea. Well, obligation is an obligation. So present obligation today, we have a debt. This is a present obligation and every time we have a debt, the debt occur as a result of a past transaction. So something happened in the past. We borrowed money, we purchased something on account. Something happened in the past. It created a current debt. So it's a current obligation. All debts need to be settled into the future because you need to settle the debt. You need to pay off the debt. So you have to pay it into the future. Now that future, if that debt has to be paid within the next 12 months or the company operating cycle using current asset, we consider this liability as a current liability. So this is what a current liability is. Now we need to define what is an operating cycle and what are current assets. We should know what current assets are, but let's go ahead and examine current assets because we cannot make that assumption. Current assets are assets that the company expect to convert into cash, sell or consume an operation within a single operating cycle or within one year. Again, this we're talking about the operating cycle again. So what is a current asset? It's an asset that's expected to be converted into cash. So simply put, cash is already a current asset because cash is already cash or we expect to sell. Well, think about inventory. Do we expect to sell inventory in the near future? Of course. So cash is a current asset. Inventory is a current asset. Consume. Well, supplies, prepaid. Those are current assets because we expect to consume them. Those are current assets and convert into cash. For example, if we have an account receivable, we're going to convert into cash and all of these are considered current assets because they are either cash themselves or they're going to be converted, sold or consumed within one year or the company's operating cycle. So what is the operating cycle? The operating cycle is cash to cash cycle. What does that mean? It means how long does it take for a company from the time to acquire goods and services to the time of sale and the subsequent receipt of cash? Think about a company like Walmart or any retailer. A retailer first, what they do is they buy inventory, they market the inventory, they put it on the shelf, then they sell it, then they have an account receivable, then they collect the cash. So they buy, they sell, they collect the cash. How long is that cycle? For most companies, this cycle is less than a year. So if it's less than a year, we assume it's one year. That's why we say within one year. Maybe some companies will have a longer operating cycle, but for our purposes, we assume the company will have an operating cycle of a year. So simply put, what we are saying is this. Any current liability that's going to be paid within one year from the balance sheet date is considered a current liability and this is the current liability definition. Now, let's take a look at some examples of current liabilities. And this is 10 types of current liabilities that we're going to be covering in these sessions. In this session, I will cover accounts payable and notes payable, which are interest-pairing and non-interest-pairing. Part two, I will cover these liabilities, dividend, customer advances on earned revenue, sales taxes payable, income taxes payable, accrued liabilities. We have many accrued liabilities. I did cover those in the adjustment chapter. You can reference that. Then I will spend one session on employee-related liabilities, part three in one session on current liabilities of long-term debt. Let's start to look at accounts payable. What are accounts payable? Accounts payable are obligations that the suppliers of merchandise or services purchase on credit. Simply put, purchase on open account. What we do is we buy goods and services and the supplier will give us 30, 60, 90 days to pay. Usually, accounts payable, usually accounts payable by its nature does not involve interest. No interest is involved. What's involved in accounts payable is a discount. Usually, the seller will offer us a discount. In other words, if we pay within a certain period of time, they'll give us a discount and the discount will be stated something like this, 2 slash 10 and 30. It means we'll get 2% if you pay within 10 days or the full amount due is in 30 days. Simply put, we have 30 days to pay. This is what we call the credit period. And within that credit period, we have 10 days and if we pay within 10 days, we get 2% off. This period is called the discount period. So let's take a look at a quick example to illustrate this concept. On June 1st, Aaron purchased $10,000 worth of inventory from Ryan. The terms were 2 slash 10 and 30. Assume perpetual inventory system. On June 1st, Adam will debit inventory, $10,000. We credit accounts payable $10,000. Now, if this was a periodic inventory system, we will debit purchases. Just I'll show you both systems. On June 11th, Adam waited until the last day of the discount period and made the payment. Once we make the payment, we have an accounts payable of $10,000. Now, we created the payable. We credit the payable. Now, we settle the payable. The payable is down to zero. We are going to pay only $9,800. Why only $9,800? It's because we purchased $10,000 worth of inventory but we're only paying 98% of the bill. Why 98% of the bill? We got 2% off. We paid within 10 days. Exactly on the 10th day, we get 2% off. Now, what happened to that $200? The $200 is we will reduce inventory, the inventory cost because we are using a perpetual inventory system. Remember, we initially recorded the inventory at $10,000 when we purchased it initially. Now, we reduce the cost by $200. So, our inventory will have a cost of $9,800. Now, if we were using a periodic inventory system, we will debit a purchase discount. And I do have a separate recording for periodic versus perpetual. I just wanted to show it to you. So, this is one of the current libraries that you need to be familiar with. In most companies, old companies will have some sort of an accounts payable because companies buy on account all the time. It's part of business, part of heaven business on credit. That's very normal. The second liability we're going to be looking at is notes payable. And specifically, we're going to be dealing with short-term because this chapter is about current liabilities. We have notes payable long-term. We have notes payable short-term. Notes payable short-term. Basically, notes payable are loans, a formal promise to pay a certain amount of money plus interest. Basically, you took money out. You borrowed money. Now, you have to pay it back with interest within one year. So, it's a result of borrowing. And sometimes what happens is a result of purchasing. Sometimes you might purchase something and rather than buying it on account, rather than buying it on account payable, the seller would ask you to sign a note. This is how account notes payable are created. Notes payable comes in two different flavors. Interest-varying. It means the interest is stated on the loan explicitly or zero or no interest-varying note. We're going to be looking at examples for both interest-varying and non-interest-varying note. Before we look at an example, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course. I'm a useful addition to your CPA review course. I can show you how to understand the material better. I can explain the concept behind the theory. I can give you examples, multiple choice, true, false. That's going to help you do better on your exam. Your risk is one month of subscription. Your potential gain is passing the CPA exam. If not for anything, take a look at my website to find out how well or not well your university is doing on the CPA exam. This is a list of all the accounting courses that I have covered, including governmental accounting, cost accounting, advanced accounting, auditing, taxation, so on and so forth. My CPA supplemental resources are aligned with your Becker, Wiley, Roger, and Gleam. This way you can go back and forth between my material and your CPA review course. I also give you access to 1500 plus in addition to my CPA questions, AICPA previously released questions with detailed solution. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter, and Reddit. So let's start by looking at a simple example that deals with interest bearing note. On April 1st, Adam borrowed $100,000 from the Bank of America for two months at 8%. Well, Adam will walk away on April 1st with $100,000 cash and will credit notes payable $100,000. Two months later on June 1st, Adam will have to pay the note 100,000, obviously, and Adam will have to pay back $100,000, $8,333. Why $100,000, $8,333? Because in addition to the $100,000, we are going to incur $8,333 of interest, which is taking the principal amount times the time times the interest rate. Therefore, notice the time is 212, only two out of 12 months, and we're going to credit cash $108,333. So this is an interest bearing note where the note is specifically identifying the interest, 8%. Let's take a look at zero interest bearing note or no interest bearing note. What is that? Well, it means that the rate is not explicitly stated on the face of the note. Let's take a look at an example. On April 1st, Adam signed a zero interest bearing note to pay $103,000 three months from now. The present value of the note is $100,000. So the present value, it means what Adam took out today. Adam took out today $100,000, but Adam will have to pay $103,000. Therefore, we credit notes payable $103, this is how much we are responsible for. The difference between the cash received and the note is called discount on notes payable, and that happens to be a debit of $3,000. Now, what is the discount on notes payable? Remember, what we did is we found the present value of this note. We discounted the note. Well, discounting the note means that note, that note, the discounted amount of the note represent the interest expense. So simply put, Adam took out $100,000, Adam will have to pay back $103,000. The difference is obviously interest, but right now, we cannot count it as interest because interest is recorded as time goes by. Well, right now, no time has passed. So what we do is we park that $3,000 in an account called discount that represent the interest expense, specifically the future interest expense. Eventually, we're going to either amortize or turn the discount into interest expense. And by the way, discount is a contra liability. Simply put, on the balance sheet, we will show the notes payable at $103,000 minus the $3,000 discount, and this is going to give us the carrying value of the note. So it's a contra liability. It reduces the note. Let's take a look at what happened later. Later, what happened is when we pay off the note, so this is when we issue the note, what's going to happen when we pay off the note, when Adam pays the note, we are going to pay the note, and we have to reduce the note by 103. So notice we have a note payable of $103,000 initially. Now we pay it off, and we're going to pay off $103,000. Are we done yet? Not yet. Now we have to turn the discount into interest. Now it's time to record the interest. We're going to debit interest expense and credit the discount. So let's see what happened to the discount. This is the discount. We had $3,000 initially. Now we credit the discount, and the discount is gone. So what happened to that $3,000? That $3,000 becomes increased interest expense. And this is what I meant to say that the discount is amortized. The discount is interest expense. It's going to turn into an interest expense. Let's take a look at another example where notes payable are created. Adam purchased inventory from Ryan Company on account for $60,000. Ryan gave Adam 30 days to pay, and we assume we're using perpetual inventory system. Adam will debit inventory $60,000, will credit accounts payable for Ryan $60,000. On October 1st, which is a month later, Adam don't have the money to pay. So on October 1st, so what happened is this, Adam asked Ryan to replace the accounts payable with the notes payable, because Ryan gave Adam 30 days to pay. Well, Adam did not have the money 30 days. So Ryan said, okay, I will give you more time, but what I'm going to do now, I want to replace the accounts payable with the notes payable. What does that mean? It means I'm going to reduce your accounts payable down to zero, and I'm going to create a notes payable, $60,000. So basically, we replaced the note, the accounts payable with the notes payable, and that's normal. That's a form of refinancing. Sometimes you might have a note and replace it with another note. We're replacing now an accounts payable with the notes payable. And notice here, it's for one year at 8%. Now we're going to give Adam more time to pay, but when Adam pays us, they will have to pay the $60,000 plus interest. So on December 31st, year one, because at the end of the year, we have to accrue any interest on that note. Well, we have $60,000 note for three months, October, November, and December times 8%, and that's going to give us $1,200. So Adam will debit interest expense $1,200, credit interest payable for Ryan's note $1,200. So this is the adjustment that we make at the end of the year to accrue the interest expense. Now, a year later on October 1st, year two, we're going to have to pay back the loan. Now it's time to pay back the loan. How much are we going to pay back? Well, we're going to have to pay back the loan plus interest. So it's a $60,000 times 8% times 12 divided by 12. We're going to pay back in total, $64,800. Well, we're going to credit cash $64,800. What are we going to debit? The first big debit, it's going to be the note itself, $60,000. The second debit will be for the interest payable amount. Remember, we accrued interest for three out of 12 months from October, November, and December. So this is October, November, and December, year one. What's left is the nine out of 12 months, which is January till October 1st, and that's going to be interest expense of $3,600. And this is for the nine 12. So notice, in total, we have interest expense of $4,800. $1,200 recorded in year one, $3,600 recorded in year two. But the total is $4,800. And notice, interest payable is technically gone. So this is the first part of the current libraries. Now the best way to learn about this is to go to my website, farhatlectures.com, and start to work multiple choice questions and additional resources to learn the material. At the end of this recording, I'm going to remind you to take a look at my website, farhatlectures.com. I'm a useful addition. When you're studying for your exam, when you're studying for your accounting career, you need to invest in yourself because you have to do once. And once you are done, that investment will pay dividend in years. And talking about dividend in the next session will look at dividend payable. Good luck, study hard, the CPA exam is worth it, and stay safe.