Current liabilities are obligations a company expects to settle within one year (or one operating cycle, whichever is longer) using current assets or by creating other current liabilities. This chapter covers the main types: notes payable, lines of credit, commercial paper, accrued liabilities, compensated absences, deposits, advances, gift cards, sales taxes, and payroll. The key theme is proper recognition and measurement: when does an obligation become a liability, and how much do you record?
Difficulty: Intermediate | Prerequisites: Chapters 1–12 foundations (basic journal entries, balance sheet classification, revenue recognition basics). Students should be comfortable with present value concepts and accrual accounting.
Current liabilities sit on the right side of the balance sheet and are central to assessing a company's short-term solvency. This is the chapter where you learn the rules for classifying what goes in "current" versus "long-term," a distinction that directly feeds the current ratio and quick ratio, two of the most-watched liquidity metrics. If you have been working through earlier chapters on assets and revenue, this is the mirror image: what a company owes, rather than what it owns. The material here also sets up the next chapter on long-term liabilities and bonds, and connects to the contingencies framework (covered in Part 3 of these notes) that determines when uncertain obligations must be recognised in the financial statements.
Current liabilities
Obligations expected to be satisfied with current assets or by the creation of other current liabilities, usually payable within one year or one operating cycle, whichever is longer. In simple terms, these are the bills a company needs to pay soon.
Notes payable
Written promises to pay a specified amount, often with interest, by a certain date. They arise from borrowing cash or purchasing goods on credit. Think of it as a formal IOU with a due date and interest terms attached.
Noninterest-bearing note
A note in which the interest is deducted (discounted) from the face amount at issuance, so the borrower receives less than face value but repays the full face amount at maturity. In simple terms, the lender takes the interest up front. The effective rate is always higher than the stated discount rate.
Line of credit
A prearranged agreement with a bank allowing a company to borrow up to a set limit, typically at a floating interest rate. Can be committed (formal, with a fee) or noncommitted (informal). Think of it as a credit card for businesses, but with a bank.
Commercial paper
Unsecured short-term notes sold in minimum denominations of $25,000, with maturities from 30 to 270 days. Issued by large, creditworthy companies directly to lenders. Think of it as a company borrowing directly from other companies, cutting out the bank.
Accrued liabilities (accrued expenses)
Expenses that have been incurred during the current period but not yet paid. Recorded via an adjusting entry debiting expense and crediting a payable. In simple terms, the work has been done or the time has passed, but the cheque has not been written yet.
Compensated future absences
A liability for employees' rights to paid time off (vacation, holidays, sick pay in certain cases) that has been earned but not yet taken. Think of it as vacation days employees have "banked" that the company still owes them.
Customer advance / unearned revenue
Cash collected from a customer before delivering goods or services. Recorded as a liability until the earning process is complete. In simple terms, the company has the money but has not yet done anything to earn it.
Refundable deposit
Cash collected from a customer that will be returned when a condition is met (e.g., returning a container). Remains a liability until refunded or forfeited. Think of it as a bottle deposit: you get it back when you return the bottle.
Gift cards / gift certificates
A form of advance collection. The seller records unearned revenue upon sale and recognises revenue either upon redemption or when the probability of redemption becomes remote (breakage). In simple terms, the company has a duty to hand over goods or services until the card is used or expires.
Sales tax payable
Amounts collected from customers on behalf of governmental taxing authorities. Not revenue to the company; purely a liability until remitted. Think of it as the company acting as a tax collector: it is holding someone else's money.
Payroll liabilities
Amounts withheld from employee wages (income tax, social security, Medicare) plus employer-borne payroll taxes (FICA match, FUTA, SUTA). Each creates a separate liability until remitted. In simple terms, the company owes money to multiple parties whenever it runs payroll: the government, insurers, and retirement plans.
SFAC No. 6 identifies three essential characteristics. A liability:
Involves probable, future sacrifices of economic benefits
Arises from a present obligation to transfer goods or provide services to another entity
Results from a past transaction or event
All three must be present. A liability involves the past (the triggering event already happened), the present (the obligation exists now), and the future (assets will be sacrificed later).
Current vs. long-term classification
Current liabilities are those expected to be settled with current assets or by creating other current liabilities. The default time horizon is one year, but a firm with a longer operating cycle uses that cycle as the threshold instead.
Valuation principle
In concept, liabilities should be reported at present value. In practice, short-term liabilities due within one year are reported at maturity amounts because the discount is immaterial. APB Opinion No. 21 (ASC 835-30-15-3) specifically exempts trade payables due within a year from present value measurement.
Interest-bearing notes
The borrower receives the face amount in cash and pays it back with interest at maturity.
At issuance: debit Cash, credit Notes Payable (face amount)
At year-end: debit Interest Expense, credit Interest Payable (accrued portion)
At maturity: debit Interest Expense (remaining), debit Interest Payable (prior accrual), debit Notes Payable, credit Cash
Interest calculation: Face Amount x Annual Rate x (Months Outstanding / 12)
Noninterest-bearing (discounted) notes
The interest is deducted from the face amount at issuance. The borrower receives less than face value.
At issuance: debit Cash (proceeds), debit Discount on Notes Payable, credit Notes Payable (face amount)
Over the life: debit Interest Expense, credit Discount on Notes Payable (amortisation)
At maturity: debit Notes Payable (face), credit Cash (face)
The effective interest rate is higher than the stated discount rate because the borrower uses less cash than the face value. Calculate it as: Discount / Cash Proceeds x (12 / Months).
Example: $10,000,000 face, 6% discount rate, 9-month note. Discount = $10M x 6% x 9/12 = $450,000. Cash proceeds = $9,550,000. Effective rate = ($450,000 / $9,550,000) x 12/9 = 6.3%.
Lines of credit
No journal entry is made when the line is established; it is disclosed in the notes.
Entries are made only when borrowing actually occurs.
Noncommitted lines are informal; committed lines charge a commitment fee (typically around 0.25% of the unused balance) and may require a compensating balance.
Commercial paper
Unsecured notes, minimum $25,000, maturities of 30 to 270 days (beyond 270 days requires SEC registration).
Interest rates are typically lower than bank loans because commercial paper is issued by large, creditworthy companies directly to the lender, and is backed by a bank line of credit.
Journal entries mirror those for notes payable.
Accrued liabilities
When an expense has been incurred but not yet paid, record it with an adjusting entry. Example: employees earn $5,000 in wages before year-end but are not paid until after. Debit Salaries Expense $5,000, credit Salaries Payable $5,000. This achieves proper matching.
Compensated future absences
An employer must accrue a liability for future paid absences (vacation, holidays) when all four conditions are met:
The obligation is attributable to services already performed
The benefit vests or accumulates
Payment is probable
The amount can be reasonably estimated
Sick pay is specifically excluded from mandatory accrual unless company custom is to pay "sick pay" even when absence is not due to illness. Sabbatical leave is accrued only if it compensates past service, not if it is granted for the employer's benefit (e.g., research).
Customer deposits and advances
When cash is collected before goods or services are delivered:
Refundable deposit: debit Cash, credit Liability (refundable deposits). When returned: debit the liability, credit Cash. If forfeited: debit the liability, credit Revenue.
Customer advance: debit Cash, credit Liability (customer advance). When goods are delivered: debit the liability and any additional cash received, credit Sales Revenue.
Gift cards
A particular form of advance collection.
At sale: debit Cash, credit Unearned Revenue (gift certificates)
At redemption: debit Unearned Revenue, credit Sales Revenue
Breakage: when the probability of redemption is viewed as remote (based on expiration or experience), the remaining unearned revenue is recognised as revenue
For classification, estimate the portion expected to be redeemed within a year (current liability) versus later (noncurrent). Any unredeemed portion expected never to be redeemed is recognised as breakage revenue.
Sales taxes
Sales taxes collected are not revenue. They are liabilities held on behalf of the government until remitted.
Journal entry at sale: debit Accounts Receivable (selling price + tax), credit Sales Revenue (selling price), credit Sales Taxes Payable (tax amount).
Tax amount = (state rate + local rate) x sales amount.
Payroll liabilities
Payroll creates two separate sets of liabilities:
Employee withholdings: federal income tax, state/local income tax, social security (6.2% of wages), Medicare (1.45% of wages), voluntary deductions (insurance, retirement contributions, union dues). These are deducted from gross pay. Net pay = gross pay minus all withholdings.
Employer payroll taxes: the employer's matching share of social security (6.2%) and Medicare (1.45%), plus FUTA (0.6% of wages) and SUTA (typically 5.4% of wages). These are an additional expense to the employer above the wages earned.
Both sets create separate liabilities until remitted. The employer's share is recorded as Payroll Tax Expense.
Interest on a note payable
Face Amount x Annual Interest Rate x (Time in Months / 12)
Effective interest rate on a discounted note
(Discount Amount / Cash Proceeds) x (12 / Months to Maturity)
Discount on a noninterest-bearing note
Face Amount x Stated Discount Rate x (Months / 12)
Cash proceeds on a discounted note
Face Amount minus Discount
Sales tax payable
(State Rate + Local Rate) x Sales Amount
Employer payroll taxes
SSI Match (6.2%) + Medicare Match (1.45%) + FUTA (0.6%) + SUTA (5.4%) = total rate applied to gross wages
Net pay
Gross Pay minus Federal Income Tax Withheld minus State/Local Tax Withheld minus Employee SSI (6.2%) minus Employee Medicare (1.45%) minus Voluntary Deductions
Commercial paper is how major corporations like Apple, GE, and Johnson & Johnson fund day-to-day operations at rates below what a bank would charge. When a retailer sells gift cards during the holidays, that flood of cash appears as unearned revenue, not sales, until customers come back and redeem them. The breakage concept (unredeemed gift cards) is a meaningful revenue line for companies like Starbucks, which reports hundreds of millions in gift card breakage annually. Payroll liabilities explain why a company's cash outflows to the government each quarter can be substantial, even for a small business: the employer matches social security and Medicare and pays additional unemployment taxes on top of what it withholds from employees.
Students often think "noninterest-bearing" means no interest is involved. It does not. The interest is simply deducted at issuance rather than paid at maturity. The borrower absolutely pays interest, and the effective rate is higher than the stated rate.
Students sometimes assume that a line of credit triggers a journal entry when it is arranged. It does not. No entry is made until the company actually borrows under the line. The line itself is disclosed in the notes only.
Students frequently confuse customer advances with revenue. Collecting cash from a customer before delivering goods is not revenue. It is a liability (unearned revenue) until the goods or services are provided.
Students sometimes classify all payroll taxes as employee deductions. The employer's matching FICA, FUTA, and SUTA are the employer's own expense, separate from amounts withheld from employee wages.
⚠️ Know how to calculate interest expense for both interest-bearing and noninterest-bearing notes, including partial-year accruals across fiscal year-ends.
⚠️ Be able to compute the effective interest rate on a discounted note. This is a classic exam calculation.
⚠️ Understand the four conditions for accruing compensated absences. Exam questions love to test whether sick pay must be accrued (answer: only if company custom treats it as general paid time off).
⚠️ Gift card breakage recognition is a frequently tested topic. Know when to derecognise the liability and recognise revenue.
⚠️ Payroll journal entries may appear as a multi-part problem. You need to record both the employee's entry (gross pay, withholdings, net pay) and the employer's entry (matching FICA, FUTA, SUTA) separately.
True or False: A noninterest-bearing note has an effective interest rate equal to its stated discount rate.
Answer: False. The effective rate is higher because the borrower receives less cash than the face amount.
Fill in the blank: A line of credit is recorded in the journal when ____.
Answer: A loan is actually made (not when the line is established).
True or False: Gift card revenue is recognised when the card is sold.
Answer: False. Revenue is recognised when the card is redeemed or when breakage is recognised.
True or False: Sick pay must always be accrued as a compensated absence.
Answer: False. Sick pay accrual is not mandatory unless company custom pays it regardless of illness.
Fill in the blank: The employer's total FICA match rate is ____.
Answer: 7.65% (6.2% social security + 1.45% Medicare).
Q: A company borrows $60 million on a 12%, 9-month noninterest-bearing note. What are the cash proceeds, and what is the interest expense recognised after 3 months?
A: Discount = $60M x 12% x 9/12 = $5,400,000. Cash proceeds = $60M minus $5.4M = $54,600,000. After 3 months, interest expense = $60M x 12% x 3/12 = $1,800,000 (credited to Discount on Notes Payable).
Q: Lizzie Corp sells $18,000 in gift cards during 2013. By year-end, $11,500 has been redeemed. In January and February of 2014, another $1,500 is redeemed. The remaining cards are viewed as expired. How much revenue does Lizzie recognise in 2013 and 2014?
A: 2013 revenue = $11,500 (from redemptions). 2014 revenue = $6,500 ($1,500 in redemptions + $5,000 breakage on expired cards).
Q: A company's total gross payroll is $500,000. Federal income tax withheld is $100,000. What is the employee's net pay, and what is the employer's total payroll tax expense?
A: Employee withholdings: $100,000 (federal tax) + $31,000 (SSI at 6.2%) + $7,250 (Medicare at 1.45%) = $138,250. Net pay = $500,000 minus $138,250 = $361,750. Employer payroll tax expense: $31,000 (SSI match) + $7,250 (Medicare match) + $3,000 (FUTA at 0.6%) + $27,000 (SUTA at 5.4%) = $68,250.
Q: What four conditions must be met to accrue a liability for compensated future absences?
A: (1) The obligation is attributable to services already performed, (2) the benefit vests or accumulates, (3) payment is probable, (4) the amount can be reasonably estimated. All four must be met.
This material connects directly to Chapter 14 (long-term liabilities and bonds) because the same recognition and measurement principles apply, just over a longer time horizon where present value becomes material. The compensated absences rules also tie into pension and post-retirement benefits, which are essentially long-duration compensated absence obligations. Gift card breakage and unearned revenue concepts link back to Chapter 5's revenue recognition principles: revenue is not recognised until earned.
current liabilities, notes payable, interest-bearing note, noninterest-bearing note, discounted note, effective interest rate, line of credit, committed line of credit, noncommitted line of credit, compensating balance, commitment fee, commercial paper, accrued liabilities, accrued expenses, compensated absences, vacation pay, sick pay, vested benefits, accumulated benefits, customer advance, unearned revenue, deferred revenue, refundable deposit, gift cards, gift certificates, breakage, sales tax payable, payroll liabilities, FICA, social security, Medicare, FUTA, SUTA, net pay, gross pay, withholdings, employer payroll taxes, ASC 710, ASC 835, APB 21, SFAC No. 6, current ratio, quick ratio, short-term solvency