ACC205 Week 4 – Discussion 1
| Current Liability |
| What is a current liability? From the perspective of a user of financial statements, why do you believe current liabilities are separated from long-term liabilities? Based on your current experience as well as any additional research you may have done, provide two examples of situations where businesses collect monies from customers and employees and report these amounts as a current liability. |
ACC205 Week 4 – Discussion 1 Answer
A current liability is a financial obligation that a company expects to settle within its normal operating cycle or within one year, whichever is longer. These are obligations that require the use of current assets or the creation of other current liabilities. The classification as current is based on the expectation that these obligations will be settled in the near term, usually within the next 12 months.
From the perspective of a user of financial statements, the separation of current liabilities from long-term liabilities is essential for understanding the company’s short-term financial obligations and its ability to meet them. Current liabilities provide insight into the company’s liquidity, short-term financial health, and its capacity to cover immediate operational needs. Long-term liabilities, on the other hand, represent obligations extending beyond the coming year and give an indication of the company’s overall financial structure and leverage.
Two examples of situations where businesses collect monies from customers and employees and report these amounts as current liabilities are:
- Customer Advances or Deposits:
- Example: A construction company receives a prepayment or deposit from a customer before starting a project. The company has not yet completed the work, so it reports this amount as a current liability until the services are delivered or the product is provided.
- Employee Withholdings:
- Example: A company withholds income taxes, Social Security contributions, and health insurance premiums from its employees’ paychecks. These amounts are collected from employees but are not immediately remitted to the relevant tax authorities or insurance providers. Until these amounts are remitted, they are reported as current liabilities on the company’s balance sheet.
These examples illustrate how current liabilities can arise from the collection of funds that are obligated to be fulfilled or remitted in the short term. Separating current liabilities from long-term liabilities helps financial statement users assess a company’s short-term financial obligations and liquidity position, providing valuable information for decision-making and analysis.
