Compiled for BAC 201 Gitagia

CURRENT LIABILITIES
A liability is an obligation, based on a past transaction, to convey assets or perform services in
the future. Liabilities are recorded when obligations are incurred.
A current liability is an obligation to be liquidated in the next twelve months. Current liabilities
include payables to suppliers, notes payable, salaries payable, advances from customers, utilities
accruals.
Current liabilities are valued at face amount. The present value is a good measure but we trade
off accuracy with convenience. A future outlay is considered a liability when it is a legally
enforceable debt.
1. Definitely determinable liabilities
These result from contracts or the operation of the legal statutes. The amount of the obligation
and its due date are known with reasonable certainty. The accounting problem is
- Ascertain existence of obligation
- Measure as accurately as possible
- Record in the accounting records

a) Trade accounts payable

The accounting procedures are generally designed so that existence, amount and due
date are readily determinable.
Terms: 2/10, n/30
1/10/Yr 1 Purchases 100,000
Accounts payable 100,000
9/10/Yr 1 Accounts payable 100,000
Cash 98,000
Purchase discount received 2,000

30/10/ Yr 1 Accounts payable 100,000

Cash 100,000
1/10/Yr 1 Purchases 196,000
Accounts payable 196,000
10/10/Yr 1 Accounts payable 196,000
Cash 196,000
31/10/Yr 1 Accounts payable 196,000
Purchase discount lost 4,000
Cash 200,000
Cut off transactions should be recorded in the correct accounting
period.

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Compiled for BAC 201 Gitagia

b) Notes payable
These are obligations in the form of written promissory notes.
They normally have face amount, interest rate, time.

A borrowed sh. 300,000 0n 1/10/Yr 2 and signed a 6 month note bearing interest at
15% p.a.
The journal entries by A are
1/10/Yr2 Cash 300,000
Notes payable 300,000

31/3/Yr 3 Notes payable 300,000

Interest expense 22,500
Cash 322,500

B purchased goods worth sh. 400,000 on 1/10/Yr2 and signed a 3 month note bearing
interest at 20% p.a.
The journal entries by B are
1/10/Yr 1 Purchases 400,000
Notes payable 400,000

31/12/Yr 1 Notes payable 400,000

Interest expense 20,000
Cash 420,000

c) Current maturities of long term debt.

The portion of a long term debt maturing within a year is reported as a current liability.
Long term debt maturing currently should not be included as current liabilities if they
are
i) To be retired by assets accumulated for this purpose that have
properly not been shown as current assets.
ii) To be refinanced, or retired from proceeds of a new debt issue or
iii) To be converted into share capital.

A company acquired a loan of sh. 10,000,000 on 1/10/Yr 3. The loan is payable

in instalments of sh. 1,000,000 every year beginning 30/9/Yr 4.

The entries to record the loan and the adjusting entry at the end of the year are
as follows.

1/10/Yr3 Cash 10,000.000

Long term loan 10,000,000

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Compiled for BAC 201 Gitagia

31/12/Yr 3 Long term loan 1,000,000

Long term loan due in one year 1,000,000

The long term loan due in one year is reported as a current liability in the
statement of financial position.

d) Dividends payable
A cash dividend payable is an amount owed by a company to its shareholders as a
result of a distribution that the board of directors has formally authorized.
Date of declaration
Date of record
Date of payment
Retained earnings XX
Dividends payable XX

Date of payment
Dividends payable XX
Cash XX

Preference shares
Dividends in arrears

e) Advances from customers

A payment in advance from a customer is a liability to supply goods or render services.
When goods are delivered or services are rendered the liability diminishes and is
transferred to revenue account.

C received sh. 340,000 to supply goods to customer on 12/4/2021. The goods were
supplied on 20/4/2021.
The entries in the books of C are
12/4/2021 Cash 340,000
Unearned revenue 340,000

20/4/2021 Unearned revenue 340,000

Sales 340,000

2. Liabilities dependent on operating results

The amount of certain liabilities is dependent on annual income which cannot be known
for certain until the end of the accounting period. After the year end when the results are
known the liabilities are readily measured.

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Compiled for BAC 201 Gitagia

i) Royalties payable
Some companies produce goods under a royalty agreement. The amount payable is not known
until the accounting period is over. XYZ ltd produces product P under a royalty agreement
where it pays sh. 5 for every unit produced. The amount is payable three months after the year
end. For the year ending 31st December 2020 300,000 units of P were produced.
31/12/2020 Royalties expense 1,500,000
Royalties payable 1,500,000
31/3/2021 Royalties payable 1,500,000

Cash 1,500,000

ii) Income Tax Payable

The amount of income tax payable is not known until the profit before tax is known.
ABC ltd reported profit before tax of sh. 5,000,000 for the year ended 31st December 2020. The
income tax rate is 30%.
Income tax expense 1,500,000
Income tax payable 1,500,000

iii) Bonus Payable

A bonus based on income will not be known until the income is determined. It is important to
define income as different definitions will give different amounts. The definitions include
i) Income before income taxes and bonus.
ii) Income after bonus but before income taxes.
iii) Net income or income after bonus and income tax.

NB: Bonus expense is a tax deductible expense

The three definitions of income should be handled independently.
PQR ltd pays its employees a bonus of 10% on income. The applicable income tax rate is 30%.
For the year ending 31st December 2020 the company reported profit before bonus and income
tax of sh. 4,000,000. Compute the bonus payable and the show the entry to record the bonus.
i) Bonus expense 400,000
Bonus payable 400,000

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Compiled for BAC 201 Gitagia

ii) Let B = bonus

B= 0.1( 4,000,000 –B)
B= 400,000 -0.1B
1.1B=400,000
B= 400,000/1.1
B= 363,636

Bonus expense 363,636

Bonus payable 363,636
iii) Let B=Bonus
T= Tax

B=0.1(4,000,000 –B-T) (i)

T= 0.3(4,000,000-B) (ii)

Substituting T in equation (i)

B= 0.1(4,000,000-B- 0.3(4,000,000-B))
=0.1(4,000,000-B-1,200,000+0.3B)
= 0.1(2,800,000-0.7B)
=280,000-0.07B
1.07B=280,000
B=280,000/1.07
261,682

Bonus expense 261,682

Bonus payable 261,682

3. Contingencies
A loss contingency is an existing, uncertain situation involving potential loss depending
on whether some future event occurs.
Whether a contingency is accrued and reported depends on
a) The likelihood that the confirming event will occur and
b) What can be determined about the amount.

Accounting standards require that the likelihood that the future event(s) will confirm
the incurrence of the liability be categorized as probable, reasonably possible or
remote.
Probable- confirming event is likely to occur.

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Compiled for BAC 201 Gitagia

Reasonably possible – the chance the confirming event will occur is more than
remote but less than likely.
Remote – the chance the confirming event will occur is slight.

Also key to reporting a contingency is the monetary amount. The amount of the
potential loss is classified as either known, reasonably estimable or not reasonably
estimable.
A liability is accrued if it is both probable that the confirming event will occur and
the amount can be at least reasonably estimated.

Loss (or expense) xx

Liability xx
Loss (or expense) xx
Asset (or valuation account) xx

If one or both of the criteria is not met, but there is at least a reasonable possibility
that the loss will occur, a disclosure note should describe the contingency. It also
should provide an estimate of the possible loss or range of loss, if possible. If an
estimate cannot be made, a statement to that effect is needed.

Shilling Amount of Potential Loss

Known Reasonably Not Reasonably
Likelihood Estimable Estimable
Probable Liability accrued Liability accrued Disclosure
And disclosure And disclosure Note only
Note Note
Reasonably Disclosure note Disclosure note Disclosure note
possible Only Only Only
Remote No disclosure No disclosure No disclosure
Required required required

PRODUCT WARRANTIES AND GUARANTEES

Product warranties and guarantees are used to boost sales. The cost of making good
on a guarantee should be recorded as expenses in the same accounting period the
products are sold (matching principle).

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Compiled for BAC 201 Gitagia

Nairobi Health, a supplier of low income health care products, introduced a new
therapeutic chair carrying a two year warranty against defects. Estimates based on
industry experience indicate warranty costs of 3% of sales during the first 12 months
following the sale and 4% the next 12 months. During December 2012, its first month
of availability Nairobi Health sold sh. 2,000,000 of the chairs.

December 2012 Cash / Accounts receivable 2,000,000

Sales 2,000,000
31/12/2012 Warranty expense 140,000
Estimated warranty liability 140,000
When claims are made and costs incurred the liability is reduced. Let’s say in 2013
the cost was sh. 61,000.

Estimated warranty liability 61,000

Cash/ Accounts payable 61,000

PREMIUMS
Cash rebates
BMX company offered sh. 2 cash rebates on a particular model of hand held hair
dryers. To receive the rebate, customers must mail in a rebate certificate enclosed in
the package plus the cash register receipt. Previous experience indicates that 30% of
coupons will be redeemed. One million hair dryers were sold in 2014 and total
payments to customers were sh. 225,000.

Promotional expense (30%*2*1m) 600,000

Estimated premium liability 600,000
Estimated premium liability 225,000
Cash 225,000

GAIN CONTINGENCIES
A gain contingency is an uncertain situation that might result in a gain. Gain
contingencies are not accrued. This is in compliance with the conservatism principle.

PRESENTATION OF CURRENT LIABILITIES IN THE FINANCIAL

STATEMENTS
Current liability accounts are commonly presented at the top in the “liabilities and
shareholder’s equity” section of the statement of financial position.
In other cases total current liabilities are deducted from total current assets to obtain
working capital.
Within the current liability section the accounts may be listed in order of maturity,
according to amount (largest to smallest) or in order of liquidation preference.

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