The current liabilities section of the balance sheet identifies those amounts due to third parties within the current year. These include accounts payable, credit card accounts, accrued payroll, taxes, unearned revenue, deposits and those amounts due within one year related to debt instruments. In general they are listed from the most immediate amounts due to those amounts due over more accounting cycles but still due within one calendar year.
This article will describe each of the respective sub-sections of the current liabilities section of the balance sheet. In addition, I will describe how to read the information in the various formats customarily found on various types of presented balance sheets.
The following sub-sections are categorized based on those accounts due within the accounting cycle (typically 30 days) and those extended out further into the current year and those within one year of the current accounting period.
Probably the one named account most customarily associated with current liabilities. Accounts payable are associated with your vendors and suppliers for the materials and/or products you sell. A good example of this is an auto parts supplier. He purchases parts from various suppliers and directly from the auto manufacturers. Most of the bills that come to the auto parts store require payment within 30 days of delivery. So the store may receive the bill 3 days after receiving the part and they have 27 days remaining to get it paid.
Sometimes the store may order a large batch of parts or supplies (oil, lubricants, fluids etc.) and they could receive a payment plan. For example, 1/3 is due within 30 days of delivery, another 1/3 in 60 days and the final 1/3 in 90 days.
Because most cases dictate payment within 30 days of delivery, this master account – ‘Accounts Payable’ is located at the top of the list of current liabilities.
It is not uncommon for small businesses to have credit cards to purchase materials and supplies while onsite at jobs or for travel purposes. Most credit cards are due within 20 days of receipt of the bill from the credit card company. So for the actual purchases you could have up to 50 days to pay for the item purchased. Therefore, because there is little more time involved in the opportunity to pay on the account, it is generally listed 2nd in line after Accounts Payable in the list of Current Liabilities.
In most business operations, there is generally a delayed payment in comparison to the actual work completed by the staff. It is not uncommon to offset the payroll payment by 7 days after completion of the payroll cycle. This is beneficial to the small business because it allows them opportunity to resolve discrepancies and properly process the payroll in a timely manner.
If you pay at the end of the accounting cycle, then approximately 7 days of payroll is unpaid and should be accounted for in the books of record for true accrual accounting. This payroll amount will be paid in the next cycle, so it is considered a liability. In addition to the gross wages, the employer often has to pay for associated benefits, retirement, and payroll taxes. Some of these taxes are not due until the end of the quarter which identifies that some of this owed money has a longer time period to pay than credit cards or traditional accounts payable.
The most common tax due is sales tax which is most often a monthly requirement. So at the end of the current accounting cycle, the amount of sales taxes collected is paid within the next accounting cycle. But some taxes are not due until closer to the end of the quarter. These include income taxes (federal and/or state), revenue based taxes, and property taxes (personal and real estate). Because this sub-section runs the entire spectrum of payment periods, this liability is placed fourth in the line-up of liabilities.
I define unearned revenue (also known as deferred revenue) as prepayments for future deliveries of product or services. In most situations customers prepay for services and/or products that will be delivered in the near future (within one accounting cycle). But it is not uncommon to have the product and/or service beyond the next accounting cycle due to contract requirements or some other trigger mechanism. Depending on the nature of the industry, it can be found closer to accounts payable, but for the small business owner, this is the best overall location within the spectrum of current liabilities.
Traditionally deposits are a formal compliance to a contract. The most common type of deposit is for utilities. Often power companies or energy suppliers require a deposit to offset a possible future failure to pay by the customer and so therefore the utility company posts this as a current liability. Other deposits are contract related and their reclassification to sales only occur based on performance in a contract. Because the performance issue is ambiguous as it relates to time (it may be well defined within the contract) this sub-section is place further away from the current accounting cycle level and closer to the extended period relationship but well within the one year limit for identification as a current liability.
Lines of Credit & Bank Notes
Here we place those current amounts due related to financial instruments (formalized documents). Most often they are lines of credit or short term notes to some institution. Notice how in this lower half of current liabilities we have accounts with documented obligations. Deposits are contractual. Bank notes are most often collateralized and so are lines of credit.
Below you will see that long-term debt is addressed and you will always find highly formalized and well collateralized lending documents.
Current Portion of Long-Term Debt
Those principle portions of each long term debt payments are referred to as the current portion of long term debt because they must be paid over the next 12 months. Most small businesses DO NOT calculate this amount nor post it in the current liabilities section of the balance sheet. It is often included in the total balance of the long term debt amount due in the long-term liabilities section. The most common reason is related to the education and experience level of the accounting staff. The formulas for this calculation are more advanced. Sometimes, owners of small businesses elect to have this done at year end by the Certified Public Accountant.
In my opinion, you only need to post this information if either of the following exist:
- You fully desire to have a true set of accrual based financial statements in compliance with Generally Accepted Accounting Principles (not required unless you are a publicly traded business); OR
- The principle portion of the long term debt that is due over the next year is a significant (greater than 3%) of total cash requirements for the same period of time. You often see this in the real estate industry whereby the principle portion amounts to large balances especially for notes that are more mature in their life cycles. Remember, as notes mature, each payment is still the same, but the interest component decreases and the principle portion increases.
As a reminder, the balance sheet is split into two halves: Assets (upper half) and the Liabilities and Equity (bottom half).
Each half has several sections and in general the following is a simplified presentation.
Other Assets __________
Total Assets $ZZZ,ZZZ
Liabilities and Equity
Long-Term Liabilities ___________
Total Liabilities $ZZZ,ZZZ
Total Liabilities and Equity $ZZZ,ZZZ
This article is focused on the Current Liabilities section. Notice its placement in comparison to Current Assets in the upper half of the balance sheet. These two current sections are used in various formulas to help the reader of the financial statements better understand the financial position of the business.
Now to the details; a fully detailed current liabilities section is presented in this format:
Liabilities and Equity
Accounts Payable $ZZ,ZZZ
Credit Cards Z,ZZZ
Accrued Payroll ZZ,ZZZ
Unearned Revenue ZZZ
Lines of Credit/Bank Notes ZZ,ZZZ
Current Portion of Long-Term Debt Z,ZZZ
Total Current Liabilities $ZZ,ZZZ
For many small business owners, this looks too much in the form of details. So many businesses consolidate the accounts to make it easier for the reader. However, as a reader, you need to understand that this format presentation gives up details for a faster read of the information. So you may see a current liabilities section look more like this:
Liabilities and Equity
Accounts Payable & CC $ZZ,ZZZ
Accrued Payroll & Taxes Z,ZZZ
Unearned Revenue & Contract Deposits Z,ZZZ
LOC/Notes & Current Portion L/T Debt Z,ZZZ
Total Current Liabilities $ZZ,ZZZ
Any of the two presentation formats are acceptable. Remember, this is your business. You can have the balance sheet presented the way you desire. You may want to take into consideration what is common to your industry. The auto parts store is going to have a different presentation format than that of a medical practitioner.
Generally Accepted Accounting Principles allow for either a highly detailed presentation format down to a one line simple format as illustrated in the simple balance sheet above. These are your statements, have them prepared the way you want.
Summary – Current Liabilities Section of the Balance Sheet
The current liabilities section of the balance sheet is found in the bottom half of the balance sheet in the liabilities section. It uses a descending age format based on the youngest or earliest due accounts to the more formal types of borrowing instruments for presentation format. This section helps the small business owner understand the amounts due over the current accounting cycle and over the next year. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you.