Current and non-current liabilities

Current and non-current liabilities explains the liabilities as in the Conceptual Framework 2018: this is the definition: A liability is a present obligationStability Ratios of the entity to transfer an economic resource as a result of past events.

A liability is defined as a company’s legal financial debts or obligations that arise during the course of business operations. Liabilities are settled over time through the transfer of economic benefits including money, goods or services. Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues and accrued expenses.

Liabilities are a vital aspect of a company because they are used to finance operations and pay for large expansions. They can also make transactions between businesses more efficient. For example, in most cases, if a wine supplier sells a case of wine to a restaurant, it does not demand payment when it delivers the goods. Current and non-current liabilitiesRather, it invoices the restaurant for the purchase to streamline the drop-off and make paying easier for the restaurant. The outstanding money that the restaurant owes to its wine supplier is considered a liability. In contrast, the wine supplier considers the money it is owed to be an asset.

Liability recognition

For a liability to be accounted for in the financial statements of the reporting entity, these three criteria from the definition must all be satisfied:

  1. the reporting entity has an obligation,
  2. the obligation is to transfer an economic resource, and
  3. the obligation is a present obligation that exists as a result of past events.

In IAS 1 Presentation of Financial Statements the classification of liabilities is further explained and defined. In IAS 32 Financial instruments: Presentation the classification of financial instruments into assets, liabilities and equity instruments is regulated.

Key points

  • Non-current liabilities, also known as long-term liabilities, are obligations listed on the balance sheet not due for more than a year.
  • Various ratios using noncurrent liabilities are used to assess a company’s leverage, such as debt-to-assets and debt-to-capital.
  • Examples of non-current liabilities include long-term loans and lease obligations, bonds payable and deferred revenue.

Examples of liability accounts in the statement of financial position are:Contingent consideration Contingent consideration Contingent consideration Contingent consideration Contingent consideration

  • Note payable, Current and non-current liabilities
  • Accounts payable / Trade creditors / Trade payables, Current and non-current liabilities
  • Salaries payable, Wages payable, Current and non-current liabilities
  • Social securities payable Current and non-current liabilities
  • Interest payable, Current and non-current liabilities
  • Accrued expenses (payable) Current and non-current liabilities
  • (Corporate) Income taxes payable, Current and non-current liabilities
  • Customer deposits, Current and non-current liabilities
  • Warranty liability, Current and non-current liabilities
  • Lawsuit payable / claims payable, Current and non-current liabilities
  • Deferred income, Unearned revenues, Current and non-current liabilities
  • Bonds payable. Current and non-current liabilities

Contra liabilities are liability accounts with debit balances. (A debit balance in a liability account is contrary—or contra—to a liability account’s usual credit balance.) Examples of contra liability accounts include:

  • Discount on Notes Payable Current and non-current liabilities
  • Discount on Bonds Payable Current and non-current liabilities
  • Debt Issue Costs Current and non-current liabilities
  • Bond Issue Costs Current and non-current liabilities

Classifications Of Liabilities On The Balance Sheet

Liability and contra liability accounts are usually classified (put into distinct groupings, categories, or classifications) on the balance sheet. The liability classifications and their order of appearance on the balance sheet are:

  • Current Liabilities – payable within 12 months after the applicable reporting date,
  • Long Term Liabilities – payable later then 12 months after the applicable reporting date.

 


Current and non-current liabilities

The classification of financial liabilities into current and non-current liabilities is governed by the condition of those liabilities at balance sheet date. Current and Non-current liabilities

Where rescheduling or refinancing is at the lender’s discretion, and it occurs after the balance sheet date, it does not alter the liability’s condition at balance sheet date. Accordingly, it is regarded as a non-adjusting post balance sheet event and it is not taken into account in determining the current/non-current classification of the debt.

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On the other hand where refinancing or rescheduling is at the entity’s discretion and the entity can elect to roll over an obligation for at least one year after the balance sheet date, the obligation is classified as non-current, even if it would otherwise be due within a shorter period. (IAS 1 73) However, if the entity expects to settle the obligation within 12 months, despite having the discretion to settle the obligation within 12 months, despite having the discretion to refinance for a longer period, then the debt should be classified to current. Current and non-current liabilities

Example – Rolling-over bank facilities

A entity has entered into a facility arrangement with a bank. It has a committed facility that the bank cannot cancel unilaterally and the scheduled maturity of this facility is 3 years from the balance sheet date. The entity has drawn down funds in this facility and these funds are due to be repaid 6 months after the balance sheet date. The entity intends to roll over this debt through the three year facility arrangement. How should this borrowing be shown in the entity’s balance sheet? Current and Non-current liabilities

The borrowing should be shown as non-current. Although the loan is due for repayment within six months of the balance sheet date, the entity is entitled to ‘roll-over’ this borrowing into a ‘new loan’. The substance is, therefore, that the debt is not repayable until 3 years after the balance sheet date when the committed facility expires. In addition, the entity expects to roll-over the debt, so does not expect to repay within 12 months.

Would the answer be different if the facility and existing draw-down loan were with different banks? Current and Non-current liabilities

The position would be different if the facility was with a different bank or if the loan was in the form of commercial paper. In the first case, the entity would have a loan repayable in six months, but would be entitled to take out a new loan to settle its existing debt.

These two loans are separate and the new loan is not, either in substance or in fact, an extension of the existing. Similarly if the loan was in the form of commercial paper, which typically has a maturity of 90 to 180 days, it would be classified as a current liability as it is likely that the backup facility would be provided by a different bank.

What Is a Liability?

A liability, in general, is an obligation to, or something that you owe somebody else. Liabilities are defined as a company’s legal financial debts or obligations that arise during the course of business operations. They can be limited, or unlimited liability. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services. Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, earned premiums, unearned premiums, and accrued expenses. Even marriages can change your liability.

In general, a liability is an obligation between one party and another not yet completed or paid for. In the world of accounting, a financial liability is also an obligation but is more defined by previous business transactions, events, sales, exchange of assets or services, or anything that would provide economic benefit at a later date. Liabilities are usually considered short term (expected to be concluded in 12 months or less) or long term (12 months or greater).

FINANCIAL RATIOS

Financial ratios

Financial ratios are the indicators of the financial performance of companies and there are different types of financial ratios which indicate the company’s results, its financial risks and its working efficiency like the liquidity ratio, asset turnover ratio, Operating profitability ratios, Business risk ratios, financial risk ratio, Stability ratios etc.

RecurringLiquidity Ratio Analysis

The first type of financial ratio analysis is the Liquidity Ratio. Liquidity ratio aim is to determine the ability of a business to meet its financial obligations during short-term and to maintain its short-term debt paying ability. Liquidity ratio can be calculated by multiple ways they are as follows:-

1 Current Ratio

Current ratio referred as a working capital ratio or banker’s ratio. Current ratio expresses the relationship of a current asset to current liabilities.

Current Ratio Formula = Current Assets / Current Liability

A company’s current ratio can be compared with past current ratio, this will help to determine if the current ratio is high or low at this period in time.

The ratio of 1 is considered to be ideal that is current assets are twice of a current liability then no issue will be in repaying liability and if the ratio is less than 2 repayment of liability will be difficult and work effects. Current and non-current liabilities

2 Acid Test Ratio/ Quick Ratio

The current ratio is generally used to evaluate an enterprise’s overall short-term solvency or liquidity position but many times it is desirable to know the more immediate position or instant debt paying ability of a firm than that indicated by the current ratio for this acid test financial ratio is used. It is relating the most liquid assets to current liabilities.

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Acid Test Formula = (Current Assets -Inventory)/(Current Liability)

The quick ratio can be written as: Current and non-current liabilities

Quick Ratio Formula = Quick Assets / Current Liabilities

Or Current and non-current liabilities Current and non-current liabilities

Quick Ratio Formula = Quick Assets / Quick Liabilities

3 Absolute Liquidity Ratio

Absolute Liquidity helps to calculate actual liquidity and for that inventory and receivables are excluded from current assets. For a better view of liquidity, some assets are excluded that may not represent current cash flow. Ideally, the ratio should be 1:2.

Absolute Liquidity Formula = Cash + Marketable Securities + Net Receivable and Debtors

4 Cash Ratio

Cash ratio is useful for a company who is undergoing is financial trouble. Current and non-current liabilities

Cash Ratio Formula = Cash + Marketable Securities / Current Liability

If the ratio is high then it reflects underutilization of resources and if the ratio is low then it can lead to a problem in repayment of bills.

Turnover Ratio AnalysisRecurring

The second type of financial ratio analysis is the Turnover Ratio. Turnover ratio is also known as activity ratio. This type of ratio indicates the efficiency with which an enterprise’s resources are utilized. For each asset type financial ratio can be calculated separately. Current and non-current liabilities

Following are financial ratios commonly calculated:- Current and non-current liabilities

1 Inventory Turnover Ratio

This financial ratio measures the relative size of inventory and influences the amount of cash available to pay liabilities. Current and non-current liabilities

Inventory Turnover Ratio Formula = Cost of Goods Sold / Average Inventory

2 Debtors or Receivable Turnover Ratio

The receivable turnover ratio shows how many times the receivable was turned into cash during the period. Current and non-current liabilities

Receivable Turnover Ratio Formula = Net Credit Sales / Average Accounts Receivable

3 Capital Turnover Ratio

The capital turnover ratio measures the effectiveness with which firm uses its financial resources. Current and non-current liabilities

Capital Turnover Ratio Formula = Net Sales (Cost of Goods Sold) / Capital Employed

4 Asset Turnover Ratio

This financial ratio reveals the number of times the net tangible assets are turned over during a year. Higher the ratio better it is.

Asset Turnover Ratio Formula = Turnover / Net Tangible Assets

5 Net Working Capital Turnover Ratio

This financial ratio indicates whether or not working capital has been effectively utilized in making sales. Net Working capital signifies the excess of current assets over current liabilities.

Net Working Capital Turnover Ratio Formula = Net Sales / Net Working Capital

6 Cash Conversion Cycle

Cash conversion cycle is the total time taken by the firm to convert its cash outflows into cash inflows (returns).

Cash Conversion Cycle Formula = Receivable Days + Inventory Days – Payable Days

Operating Profitability Ratio AnalysisRecurring

The third type of financial ratio analysis is the Operating Profitability Ratio. Profitability ratio helps to measure the profitability of a company through this efficiency of business activity. Following are the important profitability ratios:-

1 Earning Margin

It is the ratio of net income to turnover express in percentage. It refers to the final net profit used.

Earning Margin formula = Net Income / Turnover * 100

2 Return on Capital Employed or Return On the Investment

This financial ratio measures profitability in relation to the total capital employed in a business enterprise.

Return on Investment formula = Profit Before Interest and Tax / Total Capital Employed

3 Return On Equity

Return on equity is derived by taking net income and dividing it by shareholder’s equity, it provides a return which management is realizing from the shareholder’s equity.

Return on Equity Formula = Profit After Taxation – Preference Dividends / Ordinary Shareholder’s Fund * 100

4 Earnings Per Share

EPS is derived by dividing the profit of the company by the total number of shares outstanding. It means profit or net earnings.

Earnings Per Share Formula = Earnings After Taxation – Preference Dividends / Number of Ordinary Shares

The investor uses all above ratio before investing and make maximum profit and analyze risk. Through ratio, it is easy for him to compare and predict the future growth of a company. It also simplifies financial statement.

Business Risk RatiosRecurring

The fourth type of financial ratio analysis is the Business Risk Ratios. Here we measure how sensitive is the company’s earnings with respect to its fixed costs as well as the assumed debt on the balance sheet.

1 Operating Leverage

Operating leverage is the percentage change in operating profit relative to sales and it measures how sensitive the operating income is to the change in revenues. Greater use of fixed costs, greater the impact of a change in sales on the operating income of a company.

Operating Leverage Formula = % change in EBIT / % change in Sales

2 Financial Leverage

Financial leverage is the percentage change in Net profit relative to Operating Profit and it measures how sensitive the Net Income is to the change in Operating Income. Financial leverage primarily originates from the company’s financing decisions (usage of debt).

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Financial Leverage formula = % change in Net Income / % change in EBIT

3 Total Leverage

Total leverage is the percentage change in Net profit relative to its Sales. Total leverage measures how sensitive the Net Income is to the change in Sales.

Total Leverage Formula = % change in Net Profit / % change in Sales

Financial Risk Ratio AnalysisRecurring

The fifth type of financial ratio analysis is the Financial Risk Ratio. Here we measure how leveraged is the company and how it is placed with respect to its debt repayment capacity.

1 Debt Equity Ratio

Debt Equity Formula = Long Term Debts / Shareholder’s Fund

It helps to measures the extent of equity to repay debt. It is used for long-term calculation.

2 Interest Coverage Ratio Analysis

This financial ratio signifies the ability of the firm to pay interest on the assumed debt.

Interest Coverage Formula = EBITDA / Interest Expense

Higher interest coverage ratios imply the greater ability of the firm to pay off its interests.

If Interest coverage is less than 1, then EBITDA is not sufficient to pay off interest, which implies finding other ways to arrange funds.

3 Debt Service Coverage Ratio (DSCR)

Debt Service Coverage Ratio tells us whether the Operating Income is sufficient to pay off all obligations that are related to debt in a year.

Debt Service Coverage Formula = Operating Income / Debt Service

Operating Income is nothing but EBIT

Debt Service is Principal Payments + Interest Payments + Lease Payments

A DSCR of less than 1.0 implies that the operating cash flows are not sufficient enough for Debt Servicing implying negative cash flows.

Stability RatiosRecurring

The sixth type of financial ratio analysis is the Stability Ratio. The stability ratio is used with a vision of the long-term. It uses to check whether the company is stable in the long run or not. This type of ratio analysis can be calculated by multiple ways they are as follows:-

1 Fixed Asset Ratio

This ratio is used to know whether the company is having sufficient fun or not to meet the long-term business requirement.

Fixed Asset Ratio Formula = Fixed Assets / Capital Employed

The ideal ratio is 0.67. If the ratio is less than 1 then it can be used to purchase fixed assets.

2 Ratio to Current Assets to Fixed Assets

Ratio to Current Assets to Fixed Assets = Current Assets / Fixed Assets

If ratio increases, profit increase and reflect business is expanding whereas if ratio decreases means trading is loose.

3 Proprietary Ratio

The proprietary ratio is the ratio of shareholder funds upon total tangible assets it tells about the financial strength of a company. Ideally, the ratio should be 1:3.

Proprietary Ratio Formula = Shareholder Fund / Total Tangible Assets

Coverage RatiosRecurring

The seventh type of financial ratio analysis is the coverage Ratio. This type of ratio analysis is used to calculate dividend which needs to be paid to investors or interest to be paid to the lender. Higher the cover the better it is. It can be calculated by the below ways:-

1 Fixed Interest Cover

It is used to measure business profitability and its ability to repay the loan.

Fixed Interest Cover Formula = Net Profit Before Interest and Tax / Interest Charge

2 Fixed Dividend Cover

It helps to measure dividend need to pay to the investor.

Fixed Dividend Cover Formula = Net Profit Before Interest and Tax / Dividend on Preference Share

Control Ratio AnalysisRecurring

The eighth type of financial ratio analysis is the Control Ratio. Control ratio from the name itself it is clear that its use to control things by management. This type of ratio analysis helps management to check favorable or unfavorable performance.

1 Capacity Ratio

For this type of ratio analysis, the formula given below will be used for the same.

Capacity Ratio Formula = Actual Hour Worked / Budgeted Hour * 100

2 Activity Ratio

To calculate a measure of activity below formula is used.

Activity Ratio Formula = Standard Hours for Actual Production / Budgeted Standard Hour * 100

3 Efficiency Ratio

To calculate productivity below formula is used.

Efficiency Ratio Formula = Standard Hours for Actual Production / Actual Hour Worked * 100

If a percentage is 100 or more it is considered to be as favorable, if a percentage is less than 100% then it is unfavorable.

Current and non-current liabilities

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