 Hello and welcome to this session. This is Professor Farhad and this session will look at current liabilities. This topic is usually covered in financial accounting as well as the CPA exam, FAR section and the ACCA exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where I house my 1500 plus accounting, auditing, finance and tax lectures. For example, this lecture is about financial accounting but I do cover 10 other courses beside financial accounting. On my website farhadlectures.com, in addition to the lectures, you can find PowerPoint slides, notes, multiple choice, true, false, CPA questions as well as practice, exercise. So what is a current liability? Current liability is simply a debt. So liability is a debt but we need to define the word current. Well, if it's a current liability, it means the company expect to pay it within one year or the operating cycle, whichever is longer. So simply put it's a liability that the company have to pay within one year or the operating cycle. Now, what do we mean by the operating cycle? Well, the operating cycle is how long does it take you to take some cash, invest the cash in something like an inventory, sell the inventory, create a receivable, collect the cash again. So how long does it take you to take some cash, invest the cash and collect the cash again with profit? Obviously, this is the whole process is to make a profit. For example, for some companies, it may take you three months. For some companies, it may take you six months. So the point is if it's less than a year, we assume your operating cycle is a year. So we always assume for financial accounting purposes, your operating cycle is a year. Now, what are some examples of current liabilities? It could be notes, basically a loan, a short term loan less than a year, accounts payable, and we look at accounts payable in a prior chapter when you buy goods and services on account, unearned revenues, and accrued liabilities. Also, we looked at those when we did the adjustments such as taxes payable, salaries and wages payable, interest payable, and many other. So we have many types of accrued liabilities. In this session, we're going to focus on notes payable and earned revenue because those are two accounts that we did not cover heavily in prior chapter, especially notes payable. What is a notes payable? Basically, a notes payable is a written promise, basically an official promise to pay money frequently issued to meet short term financial need. It could be short term or, you know, notes could be short term or long term, but if we're dealing with current liabilities with notes payable, it must be short term. It requires the borrower to pay interest. Of course, when you borrow money, you have to pay interest and issues issued for varying periods. So it could be issued for three months, six days, 12 days, whatever amount you would like based on your needs. So let's take a look at some entries to see how it works. So First National Bank agrees to lend $100,000 on September 1, 2019 if Cole Williams Company signs a 100,012% four month note maturing January 1st. So simply put, Cole Williams wanted to borrow $100,000 on September 1st. It won't mature. It means they have to pay it back January 1st. First, we let's do the entry for the borrowing. When we borrow the money, Williams would debit cash credit notes payable. What we just did, we just created a liability called notes payable. And from a T account perspective, we have a notes payable and we have $100,000 in liabilities. Now, we lend the money, we lend the money, September 1st, and we're going to year one, this is year one, and we're going to pay it back. I'm going to do this in a different color, January 1st. So simply put, we're going to pay it right here the following day. What happened? From September 1st till December 31st, we have to accrue the interest. What does it mean accrue the interest? It means we have to compute our interest expense for that period. Well, it's a $100,000 loan times 12% and we're going to multiply by September, October, November, and December. We're going to multiply this by the time is 4 divided by 12 because we are computing the interest for 4 out of 12 months. All in all, this should be equal to 4,000. On December 31st, we debit interest expense 4,000, credit interest payable 4,000. Now what we just did, we just created another liability in addition to the notes payable. Now we have interest payable, which is an accrued liability. We accrued a liability of $4,000. Now January 1st, the following day, we're going to go ahead and prepare the entry on the maturity date. On the maturity date, we have to pay all the interest. So what's all the interest? Again, I'll do the computation again. It's 100,000 times 12% times 4 divided by 12. We have to pay back an interest 4,000 and we have to pay back the principal amount. So we have to pay the note. So basically, we're going to debit the note 100,000. Therefore, the note is gone. We're going to pay off the interest. We're going to debit note interest payable 4,000. The interest is gone. And we have to pay in cash $104,000. So what we did is we borrowed money, accrued the interest, paid the note with the accrued interest. The next liability we're going to be looking at, which is a current liability, is sales taxes payable. And what is sales taxes payable? When you buy something from a store, if you go to Wawa by a cup of coffee or if you go to the mall, buy a shirt, a pants, whatever you're buying, you're going to have to pay taxes. Those taxes are called sales tax. Simply put, you pay more than what's, for example, if there's something for $50, you might end up paying $50 plus $3 in taxes, which is you end up paying $53. Why $3 in taxes? Because the government would like to have the local, the state, whatever government has jurisdiction, you need to pay them what's called a sales tax. So it's a $50 times 6%, then you'll pay that amount, whatever that amount is. Now, sales taxes are expressed as a stated percentage of the sales price. So basically, it's usually a sales percentage. For example, in New York City, there's a sales tax of $8 in Pennsylvania, 6%. And I know many people in New York, they travel to Pennsylvania to buy their clothing or any items because it's cheaper. Actually, let's make the example a little bit more extreme. For example, in Delaware, there is no sales tax. So for example, people drives to Delaware to buy high priced item. So this way they're on pay sales tax. Now by law, you're supposed to file, when you file your income tax return, you're supposed to claim it, but that's beyond the scope of this lecture. So retailers, selling companies collect tax from the customer, enters that tax separately in a cash register, or include it in the total, but they have to keep track of it, then re-emit the collection to the State Department of Revenue. So simply put in Pennsylvania, they send the money to Harrisburg to the state capital. So you collect the money and you send it to the state. Let's take a look at an example, March 25th. The cash register reading for this grocery shows sales of 10,000 and sales tax of 600. We made sales of 10,000, but we also collected 6% sales tax. Therefore, we collected in total 10,000 plus 600, 10,600. We credit sales revenue only 10,000 because this is the sales. Then we have a liability called sales taxes payable. Now we have sales taxes payable. We just created $600 liability. Now eventually, we're going to send this money to Harrisburg when we send the money. We debit sales taxes payable 600 and we credit cash 600. So this is the adjusting entry A and A. This is the adjusting entry and basically this will be common. So basically we're left with 10,000 cash, 10,000 revenue. Now sometime what happened is the company do not enter the sales tax separately. What does that mean? It means what they do, enter the total receipts of 10,600. So when they collect the money, they don't separate the sales tax from the tax because the amount received from the sale is equal to the sales price. It's 100% plus 6% tax. So what happened? Some companies, which it's a bad habit, but some companies do it, they don't, like for example, you'll pay the price for an item and the price includes the sales tax. Simply what does that mean? It means the company will have to go back and back out the sales tax. So if the company collected in total 10,600, if they collected in total 10,600, the sales tax is 6%. You will take 10,600 divided by 1.06. They will back out the revenue account. So this is the revenue. So what's left? If the revenue is 10,600 must then sales tax. So you don't collect it up front, you'll back it out. Therefore the entry that we make is cash 10,600, credit sales revenue, 10,000 and credit sales tax is stable. So basically you have to back out the sales tax from the total. So you pay one price, they don't tell you, you don't pay sales tax, but you do. It's included in the price, but it's the job of the retailer, the job of the seller is to back it out. Another common current liability we have to deal with is unearned revenue. And what is unearned revenue? Unearned revenue is when someone pays you upfront for services that for services that you have not performed. So simply put, they will pay you upfront for something that you did not, you did not, you did not complete yet. So what do you do with this? Revenue received before the company deliver goods or services. So when somebody pays you cash, you debit cash and when you did not do the work yet, you credit unearned revenue, you credit unearned revenue. So when does that happen? It happens when airline companies, they get your money upfront, but really they don't have revenue until you travel, magazine publishers, if you are still subscriber to a magazine, a physical magazine, hotels you pay before you, before they provide the service. Another example will be, let's assume Superior University sells 10,000 season football tickets at $50 each for its five home game schedule. So when they sell the tickets, they may sell them sometime in August before the season start. So they will debit cash half a million, which is great. They will credit, well, it's August 6th, they will credit unearned ticket revenue half a million. Now those tickets are for five games. So what's going to happen is this, as the team play each game, as the team play each game, they will debit, for example, September 7th, they play the first game, they will debit, they would reduce unearned revenue 100,000. Now we still have 400,000 because this is unearned revenue. We debit unearned revenue 100,000. We still have 400,000 and we credit revenue 100,000. We credit revenue 100,000. Another liability is current liabilities, which is called current maturities of long term debt. And what is that? Simply put, if you have a long term loan, if you have a loan for let's assume five years, this is year one, year two, year three, year four, and year five. What's going to happen is this because this is a long term loan. Let's talk about current liabilities, specifically current maturities of long term debt. What does that mean? Let's assume you have a loan for five years. This is year one payments, year two, year three, year four, and year five. This is considered five, five year loan. Why it's a long term loan? Why it's a long term loan? Because it's going to be with us for five years. However, what's going to happen is this year, year one, the payment that we're going to be making in the next year, this is considered current portion. So this is the current portion. What does that mean? It means year two, year three, year four, and year five are the long term portion. So you have a current portion, you have a current portion, and you have a long term portion. Okay. Portion of the long term that that's due within the current year is considered current. And there's no adjusting entry here to make. And I remember from work, because we dealt with a lot of medium and small businesses, and they have many loans, old businesses have loans, but when you are dealing with medium sized businesses, they have many types of loans. And I still remember breaking down those into current and long term debt. So let's take a look at an illustration. Let's assume 1D construction issued a five year interest bearing note, 25,000 on January 1st. This note specified that each January 1st, Wendy should pay 5,000, 5,000 of the note. So when we prepare the financial statement, it's a $25,000 loan. What's going to happen is every year we'll pay 5,000. So what amount of this liability is considered current? Well, 5,000 is current because within year we have to pay 5,000. What remains is the long term portion, which is 20,000. So notice 20 plus 5, the loan is 25,000. 5,000 will be considered current, and 20 will be considered long term. We call this as current portion or current maturity of long term debt. We called it 20,000 long term debt net of short term portion, short term portion. So you may see this language. So you know what it means in case you saw it in the financial paper. Let's take a look at a few examples real quick. Cash is borrowed on a $50,000 6 month, 12% note on September 1st. How much interest expense you would incurred by December 31st? So you borrowed $50,000. You borrowed $50,000 on September 1st, and it's due six months later. But the question is, how much interest is accrued as of December 31st? Well, you have September, October, November, and December. You have September, October, November, and December. You have to compute the interest for four months. So you're going to take $50,000 times 12% times 4 divided by 12. So as of December 31st, you have $2,000 of accrued interest. What do you do on that date? You debit interest expense for $2,000. It's accrued, and you credit interest payable of $2,000. That's what you would do. How much is the sales tax? How is the sales tax amount determined when the cash register includes the sales tax? So what does that mean? It means when you collect the money and you collected $400,000 in total, and you did not separate the sales tax from the revenue. So let's assume in your state, the sales tax is 6%. What you do to back out the sales revenue from the sales tax, you will take the amount 400,000, 400,000 divided by 1.06. So 377,358, 377,358. That's your sales 400 divided by 1.06. Now you take 400,000 minus 377,358, and you will find your sales tax. So you back it out. So divide the total cash register by 100% plus the sales tax, 100% plus the sales tax, then subtract the sales revenue from the amount of the revenue, the total 400,000 minus that amount. If $15,000 is collected in advance on November 1st for three-month rent, what amount of rent revenue would be recognized December 31st? So you collected $15,000 and it's for three-month. Therefore, each month you are going to recognize $5,000. So if you collected this money in November, November 1st, you're going to have November and December because it's not going to end until January. So for the year December 31st, you have two months. Two months is going to give you $10,000 worth of revenue, which is two-third, and you would still have $5,000. So let's do the entry anyway. So you receive the money upfront. You debit cash $15,000. You credit unearned revenues $15,000. This is November 1st. This is November 1st. On December 31st, you earn two out of three months. Two out of three months is debit unearned revenue $10,000. Credit revenues $10,000. From a T-account perspective, from unearned revenues, you had $15,000. You reduced it by $10,000. You still have $5,000 for the month of January. And the next session would look at payroll and payroll taxes table. As always, I would like to remind you to visit my website as I do have additional resources, such as PowerPoint slides, notes, practice exercises. 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