What are ‘Current Liabilities’
Current liabilities are a company’s debts or obligations that are due within one year, appearing on the company’s balance sheet and include short term debt, accounts payable, accrued liabilities and other debts.
Essentially, these are bills that are due to creditors and suppliers within a short period of time. Normally, companies withdraw or cash current assets in order to pay their current liabilities.
BREAKING DOWN ‘Current Liabilities’
Analysts and creditors will often use the current ratio, (which divides current assets by liabilities), or the quick ratio, (which divides current assets minus inventories by current liabilities), to determine whether a company has the ability to pay off its current liabilities.
In the course of conducting its operations, a company may obtain short-term loans or acquire input materials and services from its vendors and pay for them at a later date. Because the company has to honor these obligations in the future as a result of past transactions or events, this gives rise to corresponding liabilities. Liabilities due on demand or within one year are classified as current liabilities on a company’s balance sheet.
Examples of Current Liabilities
Accounts payable is typically one of the largest current liability accounts on a company’s financial statements, and it represents any unpaid invoices a company has from its suppliers of materials and services used in the production process. Other names for current liability accounts vary by industry or government regulation, and also include dividend payable, customer deposits, current portion of deferred revenue, current maturities of long-term debt and interest payable. Sometimes, companies use an account called other current liabilities as a catch-all line item on their balance sheets to include all other liabilities due within a year not classified elsewhere.
Accounting for Current Liabilities
When a company determines it received an economic benefit that must be paid within a year, it must immediately record a credit entry for a current liability. Depending on the nature of the received benefit, the company’s accountants classify it as either an asset or expense. For example, consider a large car manufacturer that receives a shipment of exhaust systems from its vendors, and must pay them $10 million within the next 90 days. Because these auto parts do not go immediately into production, the company’s accountants record a credit entry to accounts payable and a debit entry to inventory for $10 million. When the company pays its balance due to suppliers, it debits accounts payable and credits cash for $10 million.
Suppose a company receives tax preparation services from its external auditor for which it must pay $1 million within the next 60 days. The company’s accountants record a $1 million debit entry to the audit services expense account and a $1 million credit entry to the other current liabilities account. When a payment of $1 million is made, a $1 million debit entry to the other current liabilities account and a $1 million credit to the cash account are made.