What is Liability in Accounting & Examples of Liabilities

What is Liability in Accounting & Examples of Liabilities

Liabilities meaning in accounts, are any debts owed by your company, such as bank loans, mortgages, unpaid bills, IOUs, or any other sum of money owed to someone else.

If you promised to pay someone money in the future and haven't done so, you have a liability.

Liabilities in Accounting

A company's liabilities are reported on its balance sheet. 

According to the accounting equation, the total amount of liabilities must equal the difference between the total amount of assets and the total amount of equity.

Liabilities + Equity = Assets

Assets - Equity = Liabilities

Accountants must report liabilities following accepted accounting principles. 

International Financial Reporting Standards are the most widely used accounting standards (IFRS).

Many countries around the world have adopted the standards. Many countries, however, have their reporting standards, such as GAAP in the United States or Russian Accounting Principles (RAP) in Russia. 

Although the liabilities are recognized and reported following different accounting standards.

Defining what are Liabilities in accounting are listed on a balance sheet according to when the obligation is due.
How to Locate Liabilities

All of your liabilities, owing to the concept of what liabilities are in accounting, can be found on your company's balance sheet, which is one of the three major financial statements. 

Every balance sheet is divided into three parts:

  • The assets section shows how much money you have.
  • The equity section shows how much you and other investors have put into your company so far.
  • The liabilities section explains what you owe.

Balance sheets were traditionally written in two columns, with the left column always reserved for assets and the right column always reserved for liabilities and equity.

Example

In this two-column format, here's a balance sheet for a hypothetical company, Samar’s Pottery Palance:

ASSETS

 

LIABILITIES

 

Cash in Bank Accounts

$4000

Accounts payable

$2000

Accounts Receivable

$2000

Short-Term Debt

$4000

Equipment

$13000

Wages Owed

$1000

Raw Materials

$3000

Total Liabilities

$7000

       
   

OWNER’S EQUITY

 
   

Capital 

$2000

   

Retained Earnings

$17000

   

Business Owner’s Draw

  • $4000
   

Total Equity

$15000

       
       

Total Assets

$22000

Total Liabilities & Equity

$22000

Isn't it interesting that Samar’s total assets equal the sum of her liabilities and equity? 

That is not a coincidence. 

Your assets should equal the sum of your liabilities and equity if your books are up to date.

Accountants refer to this relationship as the accounting equation, and it is the most important equation in accounting. 

You can express it mathematically as follows:

Liabilities + Equity = Assets

If your assets do not equal your liabilities and equity, the two sides of your balance sheet will not 'balance,' the accounting equation will not work, and you have likely made an accounting error.

The two-column balance sheet format is becoming less popular. Your accounting software may generate your balance sheet in a single column, as shown below:

ASSETS

 

Cash in Bank Accounts

$4000

Accounts Receivable

$2000

Equipment

$13000

Raw Materials

$3000

LIABILITIES

 

Accounts Payable

$2000

Short-Term Debt

$4000

Wages Owed

$1000

Total Liabilities

$7000

   

OWNER’S EQUITY

 

Capital 

$2000

Retained Earnings

$17000

Business Owner’s Draw

-$4000

Total Equity

$15000

The important thing to remember here is that if your numbers are correct, all of your points relating to what are the liabilities in accounting liabilities should be neatly listed under your balance sheet "liabilities" section.

What are the liabilities in different manners?

Current liabilities vs non-current liabilities

The primary classification of liabilities and standing to the liability meaning in accounts is based on their maturity date. 

The classification is critical to the company's financial obligations management.

Current liabilities are those that must be paid within one year. 

These mostly happen as part of normal business operations. 

Because of the short-term nature of these financial obligations, they should be managed with the company's liquidity in mind. 

The following are the most common current liabilities:

Accounts payable:

These are the bills owed to the company's vendors that have yet to be paid. 

Accounts payable are typically the most significant current liability, meaning in accounts for most businesses.

Interest payable refers to interest expense that has already been incurred but has not yet been paid. 

Interest payable is not the same as interest expense, which appears on an income statement.

Income taxes payable:

The amount of income taxes owed to the government by a company. 

In most cases, the tax amount owed must be paid within one year.

Otherwise, the tax would be considered a long-term liability.

Bank account overdrafts:

A type of short-term loan is provided by a bank when a payment is processed, but there are insufficient funds in the bank account.

Accrued expenses are those that have been incurred but for which no supporting documentation (e.g., an invoice) has been received or issued by the vendor.

Revenue deferred: (also called unearned revenue). 

When a company receives advance payment for goods and/or services that have yet to be delivered or completed.

Short-term loans or the current portion of long-term debt: loans or other borrowings with a one-year or less maturity.

Current liabilities play an important role in several short-term liquidity measures.

The metrics listed below are examples of what management teams and investors look at when performing financial analysis on a company.

What are the liabilities Key ratios:

  • The current ratio is calculated by dividing current assets by current liabilities.
  • The quick ratio is calculated as current assets minus inventory divided by current liabilities.
  • The cash ratio is calculated by dividing cash and cash equivalents by current liabilities.
  • Non-current (long-term) liabilities are those due in more than a year. 
  • Non-current liabilities must exclude amounts due in the short term, such as short-term loans or the current portion of long-term debt.
  • Non-current liabilities, as well as amounts arising from business operations, can be sources of financing. 
  • Bonds or mortgages, for example, can be used to fund a company's projects. 
  • Non-current liabilities are critical to understanding a company's overall liquidity and capital structure. 
  • If a company is unable to repay its long-term liabilities as they become due, it will face a solvency crisis and possibly bankruptcy. 

Long-term liabilities include the following:

Bonds payable: The total amount of outstanding bonds issued by a company with maturities of more than one year. 

The bonds payable account on a balance sheet represents the value of the company's outstanding bonds.

Notes Payable 

The total amount of promissory notes issued by a company with maturities of more than one year.

Leases 

Leases are recognized as a liability when a company enters into a long-term rental agreement for property or equipment. 

The lease amount is the present value of the lessee's obligation. Contingent liabilities are a special category of liabilities. 

They are possible liabilities that may or may not arise depending on the outcome of an uncertain future event. 

A contingent liability is recognized only if both of the following conditions are met: 

The outcome is probable the liability amount can be reasonably estimated. 

If one of the conditions is not satisfied, a company does not report a contingent liability on the balance sheet.

However, it should disclose this item in a footnote on the financial statements.

One of the most common examples of contingent liabilities is legal liabilities. Suppose that a company is involved in litigation. 

Due to the stronger evidence provided by the opposite party, the company expects to lose the case in court, which will result in legal expenses. 

The legal expenses may be recognized as contingent liabilities because the expenses are probably the legal expenses that can be reasonably estimated (based on the remedies asked by the opposite party)

The notes payable account on a balance sheet, like bonds payable, shows the value of promissory notes.

Deferred tax liabilities are the difference between the amount of tax recognized on the income statement and the actual tax amount owed to the appropriate tax authorities. 

As a liability, it essentially means that the company "underpays" taxes in the current period and will "overpay" taxes later.

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Mortgage payable/long-term debt:

When a company obtains a mortgage or long-term debt, the value of the borrowed principal amount is recorded on the balance sheet as a non-current liability.

FAQs related to Liability In Accounting

1. What is the relationship between liabilities, assets, and equity?

What a company owns or what others owe it are its assets. What the company owes others is referred to as its liabilities. After totalling assets and subtracting liabilities from the balance, equity is the remaining amount or net worth. When a company increases its liability, or debt, without increasing its assets, its equity value decreases.

2. What is the distinction between a liability and a cost?

Though they both represent an organization's cash outflow, expenses and what are liabilities differing significantly. Expenses are deducted from income, and liabilities are deducted from assets. Expenses are the costs incurred to keep the business running on a daily basis. They are typically recurring monthly expenses. Liabilities are a reflection of future debts owed.

3. What is the significance of liabilities?

This article is provided solely for informational purposes and does not constitute financial advice. Consult a licensed professional if you are having any problems.

4. What is the current liabilities formula?

Current liabilities are debts that a company must repay within one year or the time it takes to buy inventory and convert it into sales. Find the total of your short-term obligations to calculate current liabilities.

 

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