Chapter 9, Problem 1Q

To determine

Define the term liability and differentiate between the current liability and long-term liability.

Explanation of Solution

Liability:

Liability is referred to as the obligation of the business towards the creditors for operating the business. Liability may be short-term or long-term depending upon the time duration in which it is paid back to the creditors.

Differences between current liability and long-term liability

• Current liabilities are those obligation of business to pay in the short-term using the current assets of the company.
• Long-term liabilities are those obligations that are expected to pay back in more than year.
• It is important to distinguish between current and long-term liabilities because it helps the investors and the creditors of the company in assessing the quantum of risk involved in the business’ obligations. Generally, most companies would like to report their liabilities as the long-term liabilities rather than current liabilities as it may make the firm to appear less risky. Long-term liabilities are better than current liabilities as the increase in current liabilities would show a less working capital (Working Capital=Current Assets-Current Liabilities).
• These firms which report their liabilities as long-term liabilities and which appear less risky may also enjoy lower interest rates on loans borrowed, and command higher stock prices in listing for new stocks.
• Both current liabilities and long-term liabilities appear in the balance sheet of the company.

Examples of current liabilities and long-term liabilities

• Examples of current liabilities: Accounts payable, Salaries and Wages payable, Interest payable, and Income Tax payable.
• Examples of long-term liabilities: Bank loans, Mortgage, Bonds payable, and Notes payable.