Notes

Liabilities represent obligations that the firm owes to external subjects like suppliers, tax authorities, employees, banks and bondholders. As the assets are ordered on the basis of their liquidity, liabilities can be listed depending on their maturity namely depending on when the obligation becomes due. In particular, liabilities can be distinguished into current and non-current liabilities.

Current Liabilities are expected to be paid with current assets within the current operating cycle of the business or within one year of the balance sheet. In the case of Kellogg's, hey represent the 30,97% of the total liabilities in 2018.

Instead, Non-Current Liabilities are obligations that the firm will settle beyond the next accounting period. The non-current liabilities of Kellogg's in 2018 are equal to 69,03%. Hence, most of the liabilities of Kellogg's will not become due in the next accounting period.

The higher weight of the non-current liabilities with respect to the current ones in consistent with the greater weight of non-current assets with respect to current assets. Such correspondence between the weights of current and non-current assets, on the one hand, and current and non-current liabilities, on the other hand, is fundamental for the effective management of the firm.

We will now discuss the current liability accounts that are common to most balance sheet.

• Accounts Payable, Obligation to pay suppliers in the near future. When Kellogg's purchases its supplies, it can decide to pay immediately for cash or to delay the payment in the future. In that case, an accounts payable is recorded. The accounts payable will disappear when suppliers are paid. For many companies, buying on credit from suppliers is a relatively inexpensive way to finance the purchase of inventory because interest does not normally accrue on accounts payable. Some managers may be tempted to delay payment to suppliers as long as possible to conserve cash. This strategy can create problems for suppliers. Most successful companies develop positive working relationships with suppliers to ensure that they receive quality goods and services. A positive relationship can be destroyed by slow payments. In addition, financial analysts become concerned if a business does not meet its obligations to suppliers on a timely basis because such slowness often indicates that a company is experiencing financial difficulties.
• Notes Payable, a note payable is a written promise to pay a stated sum (principal) at one or more specified future dates. An example is when Kellogg's borrows money from banks or creditors to make its investments. In this case, Kellogg's recognizes a notes payable representing an obligation to pay banks and creditors. The obligation implies the payment of the principal (namely the amount of money that Kellogg's received from the bank or the creditor) + payment of interest expenses. Interest expenses are computed by multiplying the principal by a given percentage, negotiated at the moment of signing the contract. They represent an expense for Kellogg's but they are a source of revenues for lenders. Indeed, lenders require the payment of interests to be compensated for others' use of their money. Notes payable are included in the current liabilities if the principal has to be paid within the next accounting period.
• Current Portion of Long-Term Debt, The distinction between current and long-term debt is important for both managers and analysts. A company must have sufficient cash on hand to repay current debt. Notes payable may have a longer maturity than just one year. In that case, they cannot be classified as current liabilities as they will become due in more than one year, rather they will be included in the non-current liabilities. However, part of such long-term notes payable may be included among the current liabilities if the firm has to pay back part of the principal within the next 12 months. Some contracts require the payment of the whole principal at the end of the contract. However, the contract can require the payment of part of the principal before the end of the contract. Thus, other than paying interests, the firm is required to pay back part of the principal with a certain frequency. When this is the case, the part of the principal of the long-term notes that the firm has to pay back in the next accounting period will be separately recognized in the balance sheet as a current maturity of a long-term debt. Once again, the current maturity of the long-term debt represents the part of the principal that the firm has to pay back in the next accounting period, excluding the interests.
• Other Current Liabilities
  • Accrued Income Taxes
  • Accrued Salaries and Wages
  • Accrued Advertising and Promotion
  • Other

Thus, other current liabilities include obligations that Kellogg's has towards tax authorities (accrued income taxes), employees (accrued salaries and wages) and other external subjects. Such current liabilities arise because Kellogg's incurred the associated expenses, but it did not pay for them yet. The payment will occur next year, and it is why we recognized such current liabilities.

For instance, in the case of accrued salaries and wages, Kellogg's had to recognize the wages in the income statement as the employees contributed to realize the products that have been sold. However, as Kellogg's did not pay them yet, at the end of the year, Kellogg's made an adjusting entry to recognize the expense and the related accrued expense payable namely the obligation towards the employees.

Next year, when employees will be paid, Kellogg's will recognize a decrease in cash and a decrease in the accrued salaries accounts as the obligation is settled.

Other than current liabilities, Companies has also non-current liabilities represented by:

• Long-Term Debt, financial obligations towards banks and creditors that will become due in more than one year. As for the notes payable, the contract underlying the long-term debt usually requires:
  • Payment of the Principal (namely the amount that the firm received from the creditor at the beginning of the contract) that can occur at the end of the contract for the whole amount or can be divided in instalments to be paid with a certain frequency.
  • Payment of Interests, computed on the basis of the principal amount and to be included in the income statement.

Once again, the long-term debt reported in the balance sheet just reflects the principal amount that the company received at the beginning of the contract and it has to pay back later on.

• Deferred Income Taxes, difference in income recognition between tax laws and accounting methods.
• Pension and other liabilities, in particular, other liabilities include Income Taxes Payable, Non-pension post-retirement benefits. Both pension and non-pension post-retirement benefits represent obligations towards employees. They are different from wages as they refer to the moment when employees will retire. When employees retire, firms need to pay them the amounts reported in these accounts.
• Contingent Liabilities, Some recorded liabilities are based on estimates because the exact amount will not be known until a future date. For example, a contingent liability is created when a company offers a warranty with the products it sells. The cost of providing future repair work must be estimated and recorded as a liability (and expense) in the period in which the product is sold. Therefore, they are firms' obligations that are less certain than those discussed so far. Such obligations are reported in the balance sheet only if they are probable, namely when we know that we have to pay but we don't know the exact amount. In that case, we recognize an expense in the income statement and a contingent liability in the balance sheet. If the obligation is not probable, it is reported in the footnotes. In the case of Kellogg's, no commitment or contingency is reported in the balance sheet. In particular, in order to be included in the balance sheet, the contingent liability has to meet two requirements:
  • The future event determining the obligation and, hence, a future economic sacrifice is probable.
  • The amount of the liability can be reasonably estimated. Note that, although the contingent liabilities are included in the balance sheet, they are kept as distinct from the other liabilities as they are less certain.
• Lease Liabilities, Companies often lease assets rather than purchase them. When a company leases an asset, it enters into a contractual agreement with the owner of the asset. In the language of contracts (and accounting), the party that owns the asset is referred to as the lessor. The party that pays for the right to use the asset is referred to as the lessee. For accounting purposes, a lessee can lease an asset by signing either an operating lease or a capital lease.
  • Operating Lease, the contract gives the firm the right to use the asset. Until 1^st^ January 2019, the equipment under operating lease would not be reported in the balance sheet among firm's assets. Thus, when the contract was signed, the firm did not own any new asset and no journal entry was required. The first journal entry was done when the firm pays the rent for the usage of the equipment. In particular, when the lease payment occurs, the firm will recognize a new (operating) expense in the income statement (i.e. rental fee) to account for the use of others' equipment. However, starting from 1^st^ January 2019, companies have to report the PPE under operating lease among their assets. Hence, the first journal entry is the recognition of the PPE and the associated lease liability (as in a capital lease).
  • Capital Lease, in this case, the contract gives the firm the option to buy the equipment at the end of the contract. As the contract gives the firm the possibility to become the owner of the equipment at the end of the contract, the firm may recognize the asset in the balance sheet. Thus, in this case, when the contract is signed, the firm will recognize a new asset in the balance sheet. At the same time, the firm will recognize a new liability towards the lessor. The liability represents the firm's obligation to pay the lessor in order to become the owner of the equipment at the end of the contract. Given that, the liability will be equal to the present value of the total rental fees that the firm has to pay in the future. The equipment will also be recognized in the balance sheet for the same amount.