What is a liability in accounting? If you’re a newbie in the business or accounting profession, you will have to learn about basic accounting principles and calculations like liabilities and assets. Assets and liabilities are the core of accounting and all business financial matters rely on them.
However, many people become confused while calculating liabilities due to the different kinds of liabilities. There are many things that are part of the company’s liabilities and company’s assets. There are chances that your finances might get wrong if you have no idea what to include in the liabilities.
In this blog, we will discuss liabilities and their different types and categories. Moreover, we will talk about the way these are included in the balance sheet. So, let’s dive deep into this accounting topic of liabilities!
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What is a Liability in Accounting?
Liability is an important part of a balance sheet and it covers all those expenses, interest payments, and accounts payables that a company have to pay. Every accrual-based accounting system has liabilities payable to the vendors, suppliers, customers and financial institutions.
The liabilities are described in the financial statement of a company. The balance sheet consists of all the assets and the liabilities of an organisation where all the assets and the liabilities must be equal to each other. The liabilities allow a company to maintain and buy new assets. The financing of the assets and business operations requires cash flow. This cash flow coming from external sources is known as liabilities.
A balance sheet consists of assets, liabilities and shareholder’s equity.
Total Assets = Total Liabilities + Shareholder’s Equity
Total Assets: The assets are all the tangible and intangible resources of an organisation and the owner will receive money upon the liquidation of these resources.
Total Liabilities: Total liabilities consist of all the due payments that a business acquired during an accounting period to finance new assets and to carry out business activities.
Shareholder’s Equity: A shareholder’s equity is the money invested by the investors into the business. It also consists of the profit reinvested earned on the equity by the company.
Difference Between Expenses and Liabilities
Liabilities are the expenses expected to be made in future as you have received money to finance your assets in the present time. Whatever amount of money you have to pay back in future is a liability. On the other hand, expenses are related to the ongoing business expenses for business operations.
For example, the monthly utility bill is an expense. On the other hand, a mortgage is a type of liability that you have to pay back as you have received an asset in return for this. It has increased the assets of your company, while utility bills is supporting your business operations only without increasing your tangible or intangible assets.
Types of Liabilities
There are two types of liabilities that are categorised on the balance sheet of every company. It helps financial managers to manage their finances and ledger accurately. Following are the two categories of liabilities that we typically see on a balance sheet.
- Non-Current Liabilities
- Current Liabilities
- Contingent Liabilities
Non-Current Liabilities
Non-Current liabilities are the long-time payables or liabilities that a company have to pay after a period of 12 months. It also consists of the time value of money. For example, leases, pensions and notes.
Following is the list of the non-current liabilities:
- Bonds Payables
- Long-term Notes Payables
- Mortgages Payables
- Deferred Tax Liabilities
- Pension Liabilities
- Lease Liabilities
Current Liabilities:
Current Liabilities must be paid within a period of less than one year. It requires the payment to the suppliers, vendors and customers within the same accounting period in which it has occurred within 12 months. Following is the list of the current liabilities added by the companies:
- A/P
- Notes Payables or Trade Notes Payable
- Unearned Revenues
- Sales Tax Payables
- Payroll Taxes Payables
- Salaries and Wages Payables
- Accrued Interest Payments
- Dividends Payables
- Current Portion of Long-term Debt
- Currently Maturing Long-Term Obligations
Contingent Liabilities
When the nature of liability is uncertain and the financial manager has no idea about the current or expected status of the payables or receivables, he puts those dues into the category of the contingent categories.
It can be explained with the help of an example. Let’s suppose a company has been sued by a customer for defective product delivery. In that case, the manager is not sure whether he will make a penalty or get a favourable judgement. So, the financial manager will put this into the contingent liability.
Following is the list of the contingent liabilities:
- Loss Contingencies
- Litigations, claims, and assessments
- Warranty liability
- Unearned warranty revenue
- Premium liability
- Environmental liabilities
The Bottom Line
Liabilities play an instrumental role in the development of assets and in financing business operations. However, liabilities can hurt a business if they are more than the assets of an organisation. So, the accounting equation requires the balancing of all the assets, liabilities and shareholder’s equity.
Similarly, there’s a difference between the expenses and liabilities. Expenses are incurred to carry out the day-to-day business expenses. On the other hand, the short-term and long-term liabilities are the due payments payable by the business in any case. They are the cash inflows to the businesses for the purpose of financing the assets.
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Disclaimer: All the information provided in this article What is a liability, including all the texts and graphics, is general in nature. It does not intend to disregard any of the professional advice.