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What is a current liability? From the perspective of a user of financial statements, why do you believe current liabilities are separated from long-term liabilities? Based on your current experience as well as any additional research you may have done provide two examples of situations where businesses collect monies from customers and employees and reports these amounts as a current liabilities.
Current liabilities are what the company owes for its debts in the next year. Long-term liabilities are those that are debts to be paid in longer than one year. Current liabilities include debts such as accounts payable, (usually the largest portion) short term loans and salaries. A company can collect monies from customers throughout the year, but this may or may not impact the overall dissolution of the total accounts payable debt. An example for this would be a company that collects $100 from customer, but the total accounts payable is over $5000. The $100 will reduce the overall accounts payable debt but will not completely reduce it. Hence, the current liability still exists.
Employees are compensated by the company for the work that they perform. Paying employees is a current liability. An employee’s salary contributes to current liability; it does not decrease it. When an employee works, they are owed money that is a debt, and in this case it is a current liability. An example of this would be an employee who works 40 hours per week and is owed their salary for this work. For this example, let’s say he is owed $500. The company must pay the employee the $500 which further increases the current liability. This is a short term debt owed to the employee.
2. A client comes to you thinking about starting a consulting business. Your client is specifically interested in what type of entity should be created for this new business. Based on your readings or any additional research you may have done, discuss the advantages and disadvantages of the following: sole proprietorship, partnership, and corporation. Based on these advantages and disadvantages provide a clear recommendation to your client.
My client has advised me that he does not have a partner and, therefore, he wants to start this consulting business alone. I have told him that a partnership is not the business that he is interested in because this type of business requires that more than one person takes on the accountability for the consulting business. If my client did have another person or a group of people that were also interested in starting this business with him, then a partnership may have been a good option to explore further.
A sole proprietorship or a corporation are good options for my client. I advise my client that a sole proprietorship is the best choice. This is because the creation of corporation is a much more formal and expensive option. To form a corporation, my client would need to file articles of incorporation, pay these fees and establish a new entity that is independently accountable for taxation. The corporation also requires the designation of a formal Board and regular meetings must be held; notes taken and reported to the governing board that created the corporation.
A sole proprietorship is considered a pass-through for taxation purposes. My client would not need to file separate taxes for his business and would, therefore, have much less paperwork to file in the long run. The start of the business would also require fewer steps and expenses.
References:
Kennon, J. (2014). Investing lesson 3: Current liabilities. Retrieved from http://beginnersinvest.about.com/od/analyzingabalancesheet/a/current
Current liabilities and employer obligations. (2014). Retrieved from http://www.principlesofaccounting.com/chapter12/chapter12.html Carter, C. (2014).
Carter, C. (2014). Differences between sole proprietorship, partnership and corporation. Retrieved from http://smallbusiness.chron.com/differences-between-sole-proprietorship-partnership-corporation-3990.html
Comparing corporations to sole proprietorship and partnerships. (2014). Retrieved from http://www.legalzoom.com/incorporation-guide/sole-proprietor-corporation-partnership-comparison.htm
