A liability obliges a company to make a payment or provide a service. It is the counterpart of an asset. Here we show you what types of liabilities there are, how they are financed and why a company should always keep an eye on them.
Liability: Meaning
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 is a liability for one party is an asset for the other - and vice versa. If a company has to pay an invoice to its supplier, this invoice is a liability for the company but an asset for the supplier.
Liabilities can be divided into two categories according to their term or maturity: current and non-current, or short-term and long-term.
Liabilities are recorded on the right-hand side of the balance sheet. They are compared to assets, which represent the assets of the company.
Assets vs. liabilities
The assets of a company are made up of various assets. These include the ownership of tangible assets, financial resources, and accounts receivable and inventory. They are thus the counterpart to liabilities, which include debts, mortgages, tax payments and account payables.
Types of liability & examples
As mentioned above, liabilities are divided into two different categories: current and non-current. Current liabilities have a short term or maturity (1 year or less). Non- current liabilities represent long-term obligations that have a maturity of more than one year.
Current liabilities
Current liabilities include:
- Salary and wage payments to employees
- Accounts payables (less than 1 year)
- Loans with a term of less than one year (e.g. overdrafts) and monthly loan instalments
- Dividends that a company must pay out to its investors
- The provision of a service when an entity has received an advance payment for it
Ideally, a company pays all its current liabilities out of its current assets, i.e. out of the income it generates from its operations. If this is not the case, and it has to take out a loan to pay its current liabilities, for example, this may indicate that its business model is not profitable enough.
Non-current liabilities
The non-current liabilities include:
- Warranty services that a company promises its customers
- Expenses for events that may occur in the future, e.g. legal costs for court proceedings
- Long-term loans with a maturity of more than one year
- Payment of pensions to employees who retire at a later date
With regard to loans, it should be noted that a loan with a long term is counted as both a current and a non-current liability: The monthly loan instalments for the next 12 months are current liabilities; the remaining amount to be paid after this period is a non-current liability.
Example: A company has taken out a loan for £50,000. It has already paid off a sum of£10,000. For the next 12 months it has to pay instalments totalling £12,000. The£12,000 is therefore a current liability; the remaining £28,000 (£50,000 - £10,000 -£12,000) is a non-current liability.
Non-current liabilities are ideally financed on a long-term basis, i.e. from future revenues. Companies must therefore regularly review their current and non-current liabilities so that they can plan their financing.
Liabilities in accounting: Why is managing them so important?
A company must always be in a position to finance its liabilities. First of all, it must ensure the financing of current liabilities, i.e. generate sufficient revenues, since current liabilities should be financed from current assets.
Non-current liabilities sooner or later become current liabilities. Financing for them must be planned in advance. A company must therefore consider how it will finance its non-current liabilities in the long term.
In accounting, liabilities are compared with assets to see how the company is financed. If you subtract the assets from the liabilities, you get the equity of a company:
Equity = Assets - liabilities
This formula shows what would remain of the company's assets if all assets were liquidated and all liabilities were settled. Equity thus represents the book value of a company and is a direct indicator of how well a company is positioned financially.
FAQs
Liabilities refer to the debt amount owed by a company to settle past transactions. The company may own this money to its suppliers, lender, bank, and other financial institutions. These are recorded as credits in the balance sheet in the order of payment terms.
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 are liabilities and its examples? ›
Liabilities are any debts your company has, whether it's bank loans, mortgages, unpaid bills, IOUs, or any other sum of money that you owe someone else. If you've promised to pay someone a sum of money in the future and haven't paid them yet, that's a liability.
What is a liability answers? ›
A liability is something an individual or organisation owes, typically an amount of cash. Recorded on the right half of the asset report, liabilities incorporate advances, accrued expenses, mortgages, bonds, accounts payable, securities, and deferred revenues.
What are the three most common types of liabilities? ›
Here is a list of some of the most common examples of current liabilities.
- Accrued expenses. These are expenses that you have already incurred and need to account for. ...
- Accounts payable. ...
- Income taxes payable. ...
- Interest payable. ...
- Unearned revenue. ...
- Short-term loans.
Liabilities can be classified into three main categories, which are:
- Current Liabilities.
- Non-current Liabilities.
- Contingent Liabilities.
Contingent liabilities are potential obligations dependent on specific future events. What are basic liabilities? Basic liabilities are financial obligations or debts that a business or individual owes to external parties.
What are known liabilities examples? ›
The most common known liabilities are accounts payable, sales tax payable, payroll liabilities, and contracted notes payable. All of these debts arise from contracts, agreements, or laws that state how much the company owes, whom it owes the money, and how much it owes.
What is liabilities for dummies? ›
In its simplest form, your balance sheet can be divided into two categories: assets and liabilities. Assets are the items your company owns that can provide future economic benefit. Liabilities are what you owe other parties. In short, assets put money in your pocket, and liabilities take money out!
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.
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 makes you a liability? ›
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 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 the 3 areas of liability? ›
Expert-Verified Answer. Physician/employers are generally responsible for three areas of liability: professional malpractice, vicarious liability, and premises liability. These areas cover errors in medical treatment, actions of employees, and the safety of the medical facility, respectively.
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 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).
