What is Liability?
Liability is a term in accounting that is used to describe any kind of financial obligation that a business has to pay at the end of an accounting period to a person or a business. Liabilities are settled by transferring economic benefits such as money, goods or services.
Liabilities are recorded on the right hand side of the balance sheet, which includes different types of loan, creditors, lender and suppliers.
Liabilities can be of short term and long term. Short term liabilities are due within an accounting period (12 months) and long term liabilities become due within a duration of more than 12 months.
Types of Liabilities
Liabilities can be classified into three main categories, which are:
1. Current Liabilities
2. Non-current Liabilities
3. Contingent Liabilities
Current Liabilities: Current liabilities are those liabilities that are due and need to be paid within an accounting period (which is usually a year or 12 months). Current liabilities are also known as short-term liabilities due to the relatively short turnaround time.
Current liabilities need to be closely monitored by the management of a company as a company needs to have sufficient liquidity in the form of current assets in order to pay off the current liabilities.
Current liabilities have a direct impact on the working capital and also on the liquidity of the business.
Some of the examples of current liabilities are:
1. Interest Payable
2. Accounts Payable
3. Short term loans
4. Accrued Expenses
5. Bank overdraft
Non-Current Liabilities: Non-current liabilities, which are also known as long term liabilities are financial obligations that are due in over a year’s time. Long term liabilities play an important role in the long term financing of the business.
These liabilities help businesses acquire capital assets by providing the required capital. Businesses can also invest in new capital projects using the funds obtained from long term debts or liabilities.
Long term liabilities are an important indicator of the solvency of the business. A company which is unable to pay off long term liabilities as and when they become due, indicates a solvency issue with the business or it signals a crisis within the business.
Investors always look at the long term liabilities of the business before investing.
Some examples of long term liabilities are:
1. Deferred tax liabilities
2. Bonds payable
3. Capital leases
4. Debentures
Contingent liabilities: Contingent liabilities are a special type of liability that may occur during the course of a business, depending on the outcome of an event that may take place in the future.
In accounting standards, contingent liabilities are recorded as potential or probable liabilities only if they have a 50% chance of occurring and when the amount of liability can be estimated properly.
Some of the examples of contingent liabilities are:
1. Product warranties
2. Lawsuits
Relation between Assets and Liabilities
Assets and liabilities are very closely related. For determining owners equity or shareholders equity, the total liabilities are subtracted from total assets. Also, the businesses which earn benefits in the short term from the current assets, use those assets for paying off the current liabilities.
The formula for shareholders equity shows
Shareholders equity or Owner’s equity = Total Assets – Total Liabilities
This was all about the topic of Liabilities – Definition and Types, which is an important topic of Accountancy for Commerce students. For more such interesting articles, stay tuned to BYJU’S.
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FAQs
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, bonds, warranties, and accrued expenses. Liabilities can be contrasted with assets.
What best defines a liability? ›
A liability is an obligation of a company that results in the company's future sacrifices of economic benefits to other entities or businesses. A liability, like debt, can be an alternative to equity as a source of a company's financing.
What is liability a type of? ›
Liability refers to a financial obligation of a company. This means that it has to pay a debt to another company or a private person. A classic example is a bank loan that must be repaid to the bank in monthly instalments.
What are 4 characteristics of liability? ›
Key Points. Some of the characteristics of a liability include: a form of borrowing, personal income that is payable, a responsibility to others settled through the transfer of assets, a duty obligated to another without avoiding settlement, and a past transaction that obligates the entity.
What is a liability and its types? ›
Liabilities encompass financial obligations and debts that individuals or entities owe. Examples include accounts payable, where a business owes money to suppliers, accrued expenses representing unfulfilled financial commitments, and business loans that indicate borrowed funds with specified repayment terms.
How do you explain liability? ›
Generally, liability refers to the state of being responsible for something, and this term can refer to any money or service owed to another party. Tax liability, for example, can refer to the property taxes that a homeowner owes to the municipal government or the income tax he owes to the federal government.
What are the three requirements for a liability? ›
The re-examination includes assessing the definition of a liability. The Boards' existing liability definitions include three criteria: (1) a present obligation; (2) a past transaction or event; and (3) a probable future sacrifice of economic benefits.
How do you classify liabilities? ›
Classification of Liabilities
Liabilities are categorized into three types: Long-term liabilities, also known as non-current liabilities; short-term liabilities, also known as current liabilities; and contingent liabilities.
What is my liability type? ›
Current liabilities are short-term debts that you pay within a year. Types of current liabilities include employee wages, utilities, supplies, and invoices. Noncurrent liabilities, or long-term liabilities, are debts that are not due within a year. List your long-term liabilities separately on your balance sheet.
How is a liability classified? ›
The Classification of Liabilities is as Follows:
Current Liabilities: These are short-term liabilities and are payable within a year. Non-current Liabilities: These are long-term liabilities and can be paid after a year or even more.
If you say that someone or something is a liability, you mean that they cause a lot of problems or embarrassment. As the president's prestige continues to fall, they're clearly beginning to consider him a liability. A company's or organization's liabilities are the sums of money which it owes.
What is categorized as a liability? ›
Liabilities are amounts owed to third parties and generally follow assets on a company balance sheet. In some cases, they're grouped in with shareholders' equity, but they're listed in the order in which they need to be repaid. Liabilities include: Accounts payable.
How is liability measured? ›
On the balance sheet, a company's total liabilities are generally split up into three categories: short-term, long-term, and other liabilities. Total liabilities are calculated by summing all short-term and long-term liabilities, along with any off-balance sheet liabilities that corporations may incur.
What are a person's liability? ›
Liabilities are debts or obligations a person or company owes to someone else. For example, a liability can be as simple as an I.O.U. to a friend or as big as a multibillion dollar loan to purchase a tech company.
What are Type 3 liabilities? ›
Type III liabilities
The third type of liabilities have uncertain future amounts but known payout dates. These are called Type III liabilities. An example of Type III liabilities are floating rate instruments and real rate bonds such as Treasury Inflation Protection Securities (TIPS).
What are 10 liabilities? ›
Accounts payable, notes payable, accrued expenses, long-term debt, deferred revenue, unearned revenue, contingent liabilities, lease obligations, pension liabilities, and income taxes payable are the ten types of liabilities in accounting that provide information about a company's financial obligations and ...
What is the best definition of a liability account? ›
A liability account is used to keep track of all legally-binding debts that must be paid to someone else. They are part of a company's general ledger and balance sheet. A liability account records amounts owed to suppliers for goods and services that were given to you on credit.
What is the standard definition of a liability? ›
Liability is a term in accounting that is used to describe any kind of financial obligation that a business has to pay at the end of an accounting period to a person or a business. Liabilities are settled by transferring economic benefits such as money, goods or services.
Which of the following can be defined as liability? ›
Liabilities refer to the monetary obligations a company may have that are payable to a different party. Liabilities are legally binding and may include employee wages and benefits, taxes, insurance, accounts payable and any expenses accrued through regular operation.
