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
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. Liabilities refer to things that you owe or have borrowed; assets are things that you own or are owed.
What are liability and types? ›
Current liabilities encompass short-term obligations payable within a year, like utilities and salaries. Long-term liabilities, such as business loans, extend beyond a year and include mortgages and bonds. Both types play a pivotal role in determining an entity's financial stability and risk management.
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 the three most common types of liabilities? ›
The most common current liabilities are:
- Accounts payable: These are the yet-to-be-paid bills to the company's vendors. ...
- Interest payable: interest expense that has already been incurred but has not been paid. ...
- Income taxes payable: the income tax amount owed by a company to the government.
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 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.
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 are the five 5 most common current liabilities? ›
Current liabilities are the sum of Notes Payable, Accounts Payable, Short-Term Loans, Accrued Expenses, Unearned Revenue, Current Portion of Long-Term Debts, Other Short-Term Debts.
What are the most common liabilities? ›
Some examples of current liabilities that appear on the balance sheet include accounts payable, payroll due, payroll taxes, accrued expenses, short-term notes payable, income taxes, interest payable, accrued interest, utilities, rental fees, and other short-term debts.
What are four examples of liability? ›
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.
Your utility bill would be considered a short-term liability. Long-term liabilities are debts that will not be paid within a year's time. These can include notes payable and mortgages, although the portion that is due within the year should be classified as a short-term liability.
What are the two major categories of liabilities? ›
Types of Liabilities. Businesses sort their liabilities into two categories: current and long-term. Current liabilities are debts payable within one year, while long-term liabilities are debts payable over a longer period.
What are the three requirements for a liability? ›
10 The Conceptual Framework further states (paragraph 4.27) that for a liability to exist three criteria must all be satisfied: (a) The entity has an obligation; (b) The obligation is to transfer an economic resource; (c) The obligation is a present obligation that exists as a result of past events.
How do you list liabilities? ›
Liabilities are ordinarily presented in the order of maturity as follows:
- Demand notes.
- Trade accounts payable.
- Accrued expenses.
- Long-term debt.
- Other long-term liabilities.
There are three primary classifications for liabilities. They are current liabilities, long-term liabilities and contingent liabilities. Current and long-term liabilities are going to be the most common ones that you see in your business.
What is the difference between debt and liabilities? ›
At first, debt and liability may appear to have the same meaning, but they are two different things. Debt majorly refers to the money you borrowed, but liabilities are your financial responsibilities. At times debt can represent liability, but not all debt is a liability.
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 two types of liabilities? ›
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.
What is an example of Type 3 liability? ›
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).
