Accounting of Current liabilities
In general a current liability is an obligation that will be satisfied within one year or one accounting period. A/C payable, Notes payable, Salary & Tax payable are the common example of current liability.
Account payable: - It represents current liability towards suppliers form whom the firm has purchased goods or service on credit. It is also known as sundry creditors.
Journals
When goods are purchased on credit/ account
Inventory / purchased a/c Dr.
To A/c payable a/c
When a/c payable is paid
A/c payable a/c Dr.
To cash a/c
Notes payable:- Notes payable , also called promissory notes is a written promise to a person or organization to pay a specific sum of money at a specified future date is called Notes payable. To the maker of the note it is a note payable. To the payee of the note it is a note receivable.
Accounting for notes payable
When interest is paid on the notes due date:-
When interest is deducted in advanced:-
Current maturities of long-term debt
Actually, this type of liabilities is long term but when payments of liabilities are partial and it may appear as short –term or current liability.
Example:- 2002 , January 1, a business house obtained a Rs. 2,00,000 loan form national bank. The term of the loan require to make payment to reduce the principle in the equal amount over 5 years, payable each January 1.
Journals
When the liabilities is classified as a current liability
When that portion is paid
Taxes payable
Other accrued liabilities
It includes any amount that has been incurred due to the passage of time but has not been paid as of the balance sheet date i.e. Wages, salary, interest payable.
Contingent liabilities: - The existence of the liability is uncertain and usually the amount is uncertain because contingent liabilities liabilities depend on some future event occurring or not occurring. The actual amount of liability must be estimated because we cannot clearly predict for future. Examples include liabilities arising form warranty and guaranty, lawsuits, income tax disputes etc.
Journals
Warranty expenses a/c Dr.
To estimated liability a/c
Balance sheet presentation
Leases
A lease is a contractual arrangement between the owner of an asset (called lessor) and the user of the assets (called lessee). Under the contract the lesser grants the lessee the right to use the assets for an agreed period of time; in turn the lessee agrees to make a series of periodic payment, called lease rent, to the lessor.
Leasing simultaneously provides for the use of assets and their financing. A common example of lease arrangement is the rental of apartment. The tenant is the lessee and the property owner is the lessor.
Types of Lease
From the viewpoint of the lessee there are two types of lease agreements, operating lease and capital lease.
Operating lease
In an operating lease, the lessee acquires the right to use an asset for a specified period of time. The lessee is not required to record the right to use the property as an asset or to record the rental obligations as liability. Therefore, operating lease is an off-balance-sheet financing but requires to mention in the financial statement as footnotes about the lease rental obligation. By escaping the balance sheet, the lease does not add to debt or impair the debt-to-equity ratio
Capital lease
The Capital Lease sometime also called Financial Lease under which the lessee acquires sufficient right of ownership and control of the property to be considered its owner. This lease is called capital lease because it is fully capitalized over the life of the lease agreement recorded on the balance sheet.
In typical Capital Lease arrangement the following procedure are undertaken.
In the first stage the firm that requires the assets selects the specific item and negotiates for price and delivery term with supplier (or manufacturer) of the assets and then negotiates with a leasing company for financing. Once the leasing terms are set, the leasing company purchased the selected item of assets from the manufacturer or distributor. When the equipment is purchased, the user firm simultaneously executes the lease agreement
To be a lease agreement, a capital lease, it should meet one or more of the following criteria:
• The lease transfers ownership of the property to the lessee at the end of the lease term.
• The lease contains a bargain purchase option to purchase the assets at an amount lower than its fair market value.
• The lease term (period) is 75% or more of the property’s economic life.
• The present value of the minimum lease payment (lease rental payments) is 90% or more of the fair market value of the property at the inception of the lease.
However, if none of the criteria is met, the lease agreement is considered to be a operating lease.
Features Operating Lease Capital Lease
1 Ownership Does not transfer to the lessee at the end of the lease term. Transfers to the lessee at the end of the lease term
2 Amortization Do not amortize the asset value fully by the payments of the lease rent over one lease term. Amortized the asset fully over one lease term by the lease rent
3 Repair and maintenance service Provided by the lessor. Does not provide by the lessor.
4 Cancelable It gives the lessee the right to cancel the lease contact before expiring the leases date if it does not require the assets more.
Does not cancelable
5 Accounting Record It is a off-balance-sheet item and do not required to record in the balance sheet It is balance sheet item and reported in balance sheet.
Capital lease and its accounting treatments
In capital lease:
The lease assets simultaneously presented in the balance sheet as lease assets and the same amount is presented as lease obligation in liabilities section.
The Lease Assets Account is a long-term asset similar to plant and equipment and therefore it is depreciable over the life of the asset.
The lease obligation is amortized over the lease period similar as to bond amortization with effective interest method.
The periodic lease payment includes both repayment of lease obligation (or principal) and interest on the obligation. And reported in income statement.
Illustration
Assume that on January 1, 1998, lessee signs a lease agreement with lessor Dealer to lease a car. The term of the agreement, specify that lessee will make annual lease payment of Rs 4000 per year for five years payable each December 31. Assume also that the lease specifies that at the end of the lease agreement, the title of the car is transferred to lessee firm.
It is a capital lease because it meets the criteria of capital lease of transferring the ownership of asset at the end of lease agreement. Now the lessee should report the lease in financial statement as;
It should report the present value of lease payments as asset and as lease obligation simultaneously. Assume that the interest rate is 8% then, the present value of lease payment is Rs 15972 (Rs 4000 * 3.993). Now, the accounting effect of capital lease on lessee firm will be as,
Transaction Assets = Liabilities + Owners’ equity
Acquired car as capital lease Rs 15,972
leased asset = Rs 15,972
lease obligation + -
The leased asset account is a long-term asset similar to plant and equipment and represents the fact that lessee has acquired the right to use and retain the asset. Thus, it is to be depreciated over the life. While depreciating the car depreciation expenses a/c is debited and accumulated depreciation-leased asset is credited.
Transaction Assets = Liab. + O.E Revenue - expenses
Charge of annual depreciation on leased asset i.e. car (15972/5) (Rs 3194)
accumulated dep.- car = - + - (Rs 3194)
depreciation expenses
On each December 31, the lessee company must make a lease rental payment of Rs 4000 to lessor Dealer. This lease payment involves both repayment of a portion of principal and interest expenses on the principal. This should be separated for each year. For this purpose the effective interest method is used as bond amortization. And this process is known as lease amortization.
Lease Amortization Schedule: Effective Interest Method.
Date (I)
Lease
Payment (II)
Interest
Expenses
(8%) (III) = I - II
Amortization
of lease obligation (IV)
Lease obligation
Jan 1, 1998 - - - Rs 15,972
Dec 31, 1998 Rs 4,000 Rs 1,278 Rs 2,722 Rs 13,250
Dec 31, 1999 Rs 4,000 Rs 1,060 Rs 2,940 Rs 10,310
Dec 31. 2000 Rs 4,000 Rs 825 Rs 3,175 Rs 7,135
Dec 31, 2001 Rs 4,000 Rs 571 Rs 3,429 Rs 3,706
Dec 31, 2002 Rs 4,000 Rs 294 Rs 3,706 Rs 0
At the end of each year (i.e. 31), the following accounting treatment is made on the book of lessee firm.
For Dec 31, 1998; similarly for other years
Transaction Assets = Liab. + O.E Revenue - expenses
For the payment of annual lease rental (Rs 4,000)
cash = (Rs 2,722)
Lease obligation + - (Rs 1,278)
Interest expenses
Balance sheet presentation as on 31 December 1998
Plant equipment and machinery:
Leased Car Rs 15,972
Less: accumulated dep. – leased Car Rs 3,194
Rs 12,778
Current liabilities:
Lease obligation
(To be met within one year) Rs 2,940
Long-term liabilities:
Lease obligation
(To be met in after one year in future) Rs 10310
