Liabilities and Reversing Entries
⚖️ Liabilities Overview
🔹 Current Liabilities
💡 Analogy: Think of current liabilities like bills due this month — things that must be paid off soon, usually within a year.
Definition: Obligations that must be settled within one year or the operating cycle, whichever is longer.
📌 Examples:
- Accounts Payable – you owe vendors
- Wages Payable – pay your employees
- Taxes Payable
- Unearned Revenue – you’ve been paid in advance but haven’t delivered yet
🔸 Long-Term Liabilities
💡 Analogy: These are like a mortgage — debts you’ll be paying for many years.
Definition: Debts that won’t be settled until more than a year from now or after the operating cycle.
📌 Examples:
- Notes Payable – formal IOUs
- Bonds Payable
- Lease Obligations
These appear below current liabilities on the classified balance sheet.
🧾 Owner’s Equity
💡 Analogy: Imagine your business is a house. If you sold it and paid off all the debt, what’s left is your equity — your claim on the value.
Definition: The owner’s residual interest in the assets after liabilities are deducted.
📌 Key Notes:
- Recorded in Owner’s Capital account
- No need to split into “current” vs. “noncurrent”
- Grows with profits, shrinks with losses or withdrawals
📉 Current Ratio
Current Ratio = Current Assets / Current Liabilities
💡 Analogy: It’s like checking how many dollars you have in your wallet for every dollar you owe this month.
Measures short-term liquidity: Can you pay your short-term debts?
- A ratio > 1 = good liquidity
- A ratio < 1 = possible trouble paying short-term obligations
📊 Example:
- Costco’s current ratio: 1.02 → healthy
- Walmart’s: 0.80 → more liabilities than assets short-term
🔄 Reversing Entries
What are they?
Optional journal entries made at the start of the new accounting period to undo certain adjusting entries from the prior period.
💡 Analogy: Like temporarily bending a rule at the end of a project, then resetting everything back to normal on Monday.
🔧 Purpose:
- Used mostly with accrued revenues and accrued expenses
- Simplifies bookkeeping and avoids double-counting
🧮 Example:
Adjusting Entry (Dec 31):
- Debit Salaries Expense
- Credit Salaries Payable
Reversing Entry (Jan 1):
- Debit Salaries Payable
- Credit Salaries Expense
This way, the usual payroll entry works without needing custom logic.
✅ Summary Table
| Concept |
Definition |
Analogy |
Key Detail |
| Current Liabilities |
Debts due soon |
Monthly bills |
Paid in ≤ 1 year |
| Long-term Liabilities |
Debts paid later |
Mortgage |
Paid > 1 year |
| Owner’s Equity |
Residual value |
Home equity |
No current/noncurrent |
| Current Ratio |
CA / CL |
Wallet-to-bills |
>1 is strong |
| Reversing Entries |
Undo adjustments |
Resetting the scoreboard |
Optional but helpful |