Financial Accounting Concepts

What are Current Liabilities? Meaning and Types

Liabilities are the obligations to pay money, render services, or deliver goods at a later date as a result of a previous transaction. This definition covers all liabilities covered in earlier chapters as well as any new liabilities. Liabilities are separated into current liabilities and long-term liabilities on the balance sheet.

Meaning of Current Liabilities

Current liabilities are those liabilities which are due within one year or one operating cycle, whichever is longer, and these are paid out of current assets.

Obligations that do not fit the definition of current liabilities are known as long-term liabilities.

Operating Cycle

The operating cycle is a concept used in the definition of a current liability. An operating cycle (also known as a cash cycle) is the period of time it takes to start with cash, purchase the things required to generate revenues (such as raw materials, supplies, labour, and/or finished goods), sell the products or services, and then obtain cash by collecting the resulting receivables. This time frame is typically no more than a few months for businesses. Given that there is no cash invested in inventory, service businesses typically have the shortest operating cycles.

Types of Current Liabilities

Clearly determinable liabilities. The existence of the liability and its amount are certain. Examples
include most of the liabilities discussed previously, such as accounts payable, notes payable, interest payable, unearned delivery fees, and wages payable. Sales tax payable, federal excise tax payable, current portions of long-term debt, and payroll liabilities are other examples.

Estimated liabilities. The existence of the liability is certain, but its amount only can be estimated. An example is the estimated product warranty payable.

Contingent liabilities. The existence of the liability is uncertain and usually, the amount is uncertain
because contingent liabilities depend (or are contingent) on some future event occurring or not occurring. Examples include liabilities arising from lawsuits, discounted notes receivable, income tax disputes, penalties that may be assessed because of some past action, and failure of another party to pay a debt that a company has guaranteed.

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