 Hello and welcome to this 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 months 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 our 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. Okay 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 gonna convert into cash and all of these are considered current assets because they are either cash themselves Or they're gonna be converted sold or consume Within one year or the company's operating cycle. So what is the operating cycle? The operating cycle is cash the cash cycle. What does that mean? It means how long does it take for a company from the time to acquire your 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 gonna 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 gonna be covering in these sessions In this session, I will cover account spable and note spable, which are interest bearing and non interest bearing Part two, I will cover these liabilities dividend customer advances on earned revenue sales tax is spable income tax is spable 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 account spable What are account spable? Account spable are obligations that to 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 account spable, usually account spable by its nature does not involve interest. No interest is involved What's involved in account spable 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 two slash ten and thirty. It means we'll get two percent if you pay within 10 days Or the full amount do is in 30 days. So simply put you we have 30 days to pay. This is what we call the credit period credit period and within that credit period We have 10 days 10 days and if we pay within 10 days, we get two percent off. This period is called the discount Period the discount period. So let's take a look at a quick example to illustrate this concept on june 1st Adam purchased 10 000 dollar worth of inventory from Ryan. The terms were two slash ten and 30 Assume a perpetual inventory system on june 1st. Adam will debit inventory $10,000 we credit account spable 10 000. Now if this was a periodic inventory system, we will debit Purchases just kind of so 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 account spable of $10,000. Now we 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 9800 why only not 9800 it's because We we paid 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 9800. 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 liabilities that you need to be familiar with In most companies all companies will have some sort of an account spable because companies buy on account all the time It's part of business part of Heaven business on credit. That's that's very normal The second liability we're going to be looking at is no spable And specifically we're going to be dealing with short term because this chapter is about current liabilities We have no spable long term. We have no spable short term No spable short term basically no spable 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 as a result of borrowing and sometime what happened is a result of purchasing Sometime you might purchase something and rather than buying it on account Rather than buying it on account spable The seller would ask you to sign a note. This is how account notes spable are created note spable Comes in two different flavors interest bearing. It means the interest is stated on the loan explicitly or zero or no interest bearing note We're going to be looking at examples for both interest bearing and non interest bearing 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 through 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 for if not for anything take a look at my website to find out how well or not well your university the wing 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 the and your CPA review course I also give you access to 1 500 plus in addition to my CPA questions AI CPA previous 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 from bank of america for two months at eight percent Well adam will walk away on april 1st with a hundred thousand dollar cash And will credit notes payable one hundred thousand dollar Two months later on june 1st adam will have to pay the note 100,000 Obviously and adam will have to pay back one hundred eight thousand three 33 why 108,333 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 2 2 out of 12 month and we're going to credit cash 108333 So this is an interest bearing note where the 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 what it means that the rate is not explicit 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 month 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 100 and 3000 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 3000 Now what is the discount on notes payable? Remember what we did is we find 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 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 3000 in an account called into a 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, this count is a contra liability simply put on the balance sheet We will show the notes payable at 103 Minus the 3000 discount and this is going to give us the carrying value of the note So it's it's a 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 see what happened at the discount. This is the discount We had 3000 initially Now we credit the discount and the discount is gone So what happened to that 3000 that 3000 becomes increased interest expense And this is what I meant to say that the discount is amortized the discount is 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 ask 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 gonna do now i want to replace the accounts payable with the notes payable What does that mean? It means i'm gonna reduce your accounts payable down to zero And i'm gonna 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 account payable with the notes payable and notice here. It's for one year At 8% now we're gonna 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 month october november and december times eight percent and that's going to give us 1200 so adam will debit interest expense 1200 Credit interest payable for ryan's note 1200 So this is the adjustment that we make at the end of the year to to accrue the interest expense Now a year later on october first year two We're gonna 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 gonna have to pay back the loan plus interest So it's a 60 thousand dollar times eight percent times 12 divided by 12 We're gonna pay back in total 64 800. Well, we're gonna 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 month, which is january till october first and that's going to be interest expense of 3600 and this is for the 912 so notice in total we have interest expense of 4800 1200 recorded in year one one 3600 recorded in year two But The total is 4800 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 farhat lectures calm and start to work multiple choice questions and In additional resources to learn the material At the end of this recording. I'm gonna remind you to take a look at my website farhat lectures calm 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 the once and once you are done That investment will pay dividend in years and talking about dividend and the next session will look at dividend payable Good luck. Study hard. The CPA exam is worth it and stay safe