2. Current Liabilities- Definition of Liability
• Liabilities represent obligations that require the future payment of
assets or performance of services.
• Not every expected future payment is a liability.
• To qualify as a liability, the future payment must be a present
obligation of the debtor that resulted from a past transaction.
• Because liabilities result from past transactions, they normally are
enforceable as legal claims against the enterprise.
• However, in some circumstances, an obligation should be recognized
as a liability on the debtor’s balance sheet, even if it is not legally
enforceable as of that date.
3. CHARACTERISTICS OF LIABILITY
There is a present duty to one or more other entities that is expected
to be settled by transfer of assets or provision of services in the
future.
It is an unavoidable obligation i.e. the duty or responsibility obligates
a particular entity.
The transaction or event creating the obligation has already occurred.
4. Definition of Current Liability
American Institute of Certified Public Accountants defined Current (short-
term) liabilities as “obligations whose liquidation is reasonably expected to
require the use of existing resources properly classified as current assets,
or the creation of other current liabilities.”
Current assets are those assets that are expected to be converted to cash
or used in normal operations during the operating cycle of the business, or
one year from the balance sheet date, whichever is longer.
The time dimension that applies to current assets also generally applies to
current liabilities. Liabilities that do not conform to this definition are
called long-term or noncurrent liabilities. Long-term liabilities are discussed
in the next lesson.
5. Types of Current Liabilities
Accounts payable, usually called traded accounts payable, arise when
an entity purchases goods, supplies, or services in the normal course
of business and there is a time lag between the time of purchase and
the time of payment.
Short-Term (Current) Notes Payable: Notes payable are written
promises to pay a certain sum of money on a specified future date
and may arise from sales, financing, or other transactions. In some
industries, notes (often referred to as trade notes payable) are
required as part of the sales/purchases transaction in lieu of the
normal extension of open account credit. Notes payable to banks or
loan companies generally arise from cash loans.
6. ILLUSTRATION ONE
On 1st October 2021, XYZ purchased goods with an invoice amount of
sh 200,000 with terms 3/20, n/60. XYZ records liabilities at the gross
amount. The full amount due was paid on 14th October 2021.
Required:
• Show the journal entries to record the above transactions. Indicate
the dates clearly.
9. Interest-bearing note issued
Interest-bearing notes specify a rate of interest.
The debtor receives cash, other assets, or services and pays back the
face amount of the note plus interest at the stated rate on one or
more interest dates.
When the stated rate approximately reflects the note’s risk, the
stated and effective interest rates are the same. This is the usual case.
12. CONTIGENCIES
A contingency is an existing condition involving uncertainty as to
possible gain or loss to an enterprise that will ultimately be resolved
when one or more future events occur or fail to occur (Chasteen,
2005).
Contingencies are classified as being either loss contingencies or gain
contingencies.
Loss contingencies are the source of contingent liabilities. They occur
when an uncertain existing condition, situation, or set of
circumstances will be resolved by the occurrence or non occurrence
of a future event that may result in impairment of an asset or the
incurrence of a liability.
13. levels of likelihood:
a) Probable- the event is likely to occur.
b) Reasonably possible- the chance that a future event will occur is
more than remote but less than probable
c) Remote- the chance that a future event will occur is slight.
The accounting treatment for a particular loss contingency depends in
part on whether the related future event has a probable, reasonably
possible, or remote chance of confirming impairment of an asset or
incurrence of liability.
14. Three ways to account for and report loss
contingencies
Accrual of an estimated loss from the contingency, which should be
reported in the body of financial statements.
Disclosure, but not accrual, of the loss contingency.
Neither accrual nor disclosure of the loss contingency.
15. Loss Contingencies That Should Be Accrued
Information available before issuance of financial statements
indicates that it is probable that an asset has been impaired or a
liability has been incurred by the date of the financial statements. It is
implicit in this condition that it must be probable that one or more
future events will occur confirming the fact of the loss.
The amount of loss can be reasonably estimated.
16. CONT.’
There are some situations when condition 1 is met but only a range
of loss can be reasonably estimated in response to condition 2. For
example, an unfavorable verdict on a lawsuit against the firm might
be probable, but the amount of loss can only be estimated to be in
the range of Sh.3 million to Sh.6 million.
In these situations, when some amount within the range appears to
be better estimate of the loss than any other amount within the
range, that amount should be accrued by a charge to income.
If no single amount within the range appears to be a better estimate
of the loss than any other, the minimum amount in the range should
be accrued
17. Guarantees and Product Warranties
Most products and services are accompanied by a guarantee or a
warranty that the product or service will be advertised and that it is
free of defects.
Guarantees and warranties typically are effective for some limited
period of time, such as 90 days or one year, during which the seller or
manufacturer will repair or replace the product without charge or will
refund some, all, or even more than the original purchase price
