Current liabilities are the enterprise’s short-term financial obligations due within one year or a standard operating cycle.
These are short-term obligations likely to be met by current assets. The operating cycle is also generally known as the cash conversion cycle. This cycle starts with sales to the conversion of cash receipts.
In-depth, it starts from the purchases of raw materials to the conversion of cash from sales. Current liabilities are settled using current assets, which will be used up within one year.
Current assets include cash or accounts receivable and other cash equivalents received as a result of sales. Examples of current liabilities include:
- Outstanding account payable
- The balance of short-term debt, such as bank loans or commercial paper issued to fund operations
- The balance of dividends payable
- Notes payable—the principal portion of outstanding debt
- Current portion of deferred revenue that recognize in the balance sheet, such as prepayments by customers for work not completed or earned yet
Accounts payable is considered as current liabilities in the balance sheet since this payable is expected to be paid by the company to its creditor within 12 months from the financial reporting date.
In the cash conversion cycle, companies match the payment dates with accounts receivables, ensuring that receipts are made before making the payments to the suppliers.
The lower the accounts payable days, the better. It reflects that the company can realize the cash in a good fashion.
An example would be: The Bold Fashions Ltd bought textile garments from Sri Textile traders as raw materials on credit. The Bold Fashions here got the inventory as a current asset while creating a short-term obligation on the other hand.
Accounting treatment in Financial Statements
Accounts payable fall under the current liabilities section, which falls under the liabilities part of the Balance sheet, as shown below:
|Liabilities and capital||Amount ($)||Assets||Amount ($)|
|Shareholders’ equity||X||Non–current Assets||X|
|Other current Liabilities||X|
Why are accounts payable a Current Liability?
When the company determines the economic benefits must be paid within a year, it should immediately record credit entries for current liability.
Reflecting on the circumstances of the received benefit, the accountants shall classify it as either asset or expense, which assumes the debit side of the entry. As the credit side is emphasized, it is a current liability.
The nature of accounts payable is a short-term obligation. The company is generally expected to pay for the purchases within 30-180 days in the general business scenario.
When the accounts payable age is greater than 180 days, serious doubts arise about the liquidity and stability of the company to meet its short-term obligations.
The common characteristics below conclude why accounts payable are within current liability:
- Both are short-term obligations to meet within the year.
- Accounts payable is a subset of current liability.
- A significant portion of working capital requires the management of accounts receivable. It accounts payable, contributing to a healthy cash conversion cycle and current liabilities.
- Both accounts payable and current liabilities result from a past transaction that obligates the entity.