Liabilities : Meaning, Types, Working & Presentation

What are Liabilities?

Liabilities are defined as anything that an individual or business owes to some other party, typically money. They are obligations that are resolved by the transfer of financial gains, such as cash, products, or services. Liabilities consist of accumulated deferred revenues, expenses, mortgages, bonds, and accounts payable. One can compare and contrast liabilities and assets. The liabilities include things that someone has borrowed and is obligated to pay back. Liabilities are classified as Current Liabilities or Non-Current Liabilities based on the company’s expected ability to settle them.

Geeky Takeaways:

• Liabilities represent financial obligations or debts that a company or individual owes to others. This could be loans, bonds, or accounts payable.
• They entail a commitment to sacrifice economic benefits in the future.
• Liabilities often arise from legal or contractual agreements. Understanding and managing liabilities is crucial for assessing an entity’s financial health.

Types of Liabilities

Businesses categorize their obligations or liabilities into two broad classifications: Current Liabilities and Non-Current Liabilities. Current Liabilities are the obligations that must be paid off within a period of one year, whereas Non-Current liabilities are loans that have a longer repayment horizon. For instance, when a business obtains a debt that must be repaid within a span of 15 years, it is classified as a long-term obligation. Nevertheless, the mortgage payments that are required to be made during the current year are classified as the current share of long-term debt and are documented in the short-term liabilities area of the balance sheet.

I. Current Liabilities

Short-term liabilities include many liabilities that are expected to be settled within a very short period of twelve months. Examples of such liabilities are Payroll Expenses and Accounts Payable, that include amounts owing to suppliers, monthly utilities, and similar expenditures. Additional examples include the following:

1. Wages Payable: Wages Payable refers to the aggregate sum of earned revenue that employees have accumulated but have not yet received. Due to the bi-weekly pay schedule commonly adopted by most organisations, this liability changes frequently.

2. Dividends Payable: It refers to the outstanding sum owed to shareholders by businesses that have issued shares and declared a dividend. The duration of this period is approximately two weeks, resulting in the frequency of this obligation four times each year.

3. Discontinued Business Liability: Liabilities arising from discontinued operations are sometimes overlooked but warrant more consideration. Companies must incorporate the financial repercussions of an operation, division, or organisation that is presently being prepared for selling or has been recently sold. This includes the financial effects of a product line that has either been discontinued or recently discontinued operations.

4. Unearned Revenues: It refer to the financial obligation of a company or business to provide goods or services in the future, for which payment has already been received in advance. The sum will be adjusted in the future by an offsetting entry after the goods or service is provided.

5. Interest Payable: Companies, similar to individuals, frequently utilise credit to acquire products and services for short-term financing purposes. This indicates the accrued interest on the short-term credit purchases that need to be repaid.

6. Accounts Payable: A business’s accounts payable consist of its immediate financial obligations to suppliers and creditors. It is identified as Current Liabilities on the Balance Sheet. Accounts Payable signifies the aggregate sum owed to vendors or suppliers in relation to invoices that have not been settled. In general, suppliers offer repayment terms of 15, 30, or 45 days, which entails the purchaser receiving the goods with the option to remit payment at a subsequent time.

II. Non-Current Liabilities

According on its name, it is apparent that any obligation that is not due in the near future is classified as Non-Current Liabilities, which are anticipated to be settled in a period of 12 months or longer.

1. Warranty Liability: Certain obligations, which are not as precise as accounts payable, need to be estimated. The term refers to the projected duration and cost associated with the repair of products as stipulated in a warranty agreement. Long-term warranties in the automotive sector are a frequent and expensive risk.

2. Deferred Credits: Deferred Credits include a wide range of transactions that can be classified as either Current or Non-Current, depending on their individual details. It might include client payments in advance, unearned income, or a transfer where reimbursements are owed but have not yet been recognised as revenue. Once the income is no longer postponed, this item is decreased by the amount obtained and becomes a component of the business’s income flow.

3. Long-Term Lease: Lease payments are another non-current liability. Commercial leases usually last over a year and require monthly payments. Office space, industrial apparatus, and cars may be leased. The company’s balance sheet would include lease-purchased property.

4. Secured and Unsecured Loans : While loans may appear to be the same as long-term loans, there are some distinctions. Borrowing can come from any business, however borrowing from a financial institution, whether secured or unsecured, comes into another category for accounting purposes. Loans are often of a longer duration, making them an excellent illustration of non-current obligations.

5. Unamortised Investment Tax Credits (UITC): This is the difference between an asset’s historical cost and what it has depreciated already. The unamortised component of the asset is an obligation, but it is merely an approximate estimate of its fair market worth. For a financial analyst, this offers insight on how aggressive or prudent a company’s depreciation techniques are.

III. Contingent Liabilities

Contingent liability is a form of debt or obligation that could arise at any time in the future. These are dependent on the occurrence of specific events. Legal expenditures incurred as a result of a lawsuit is a typical instance of a contingent liability. For example, if an organisation wins the lawsuit and doesn’t have to spend any money, it is not required to pay off the debt. If the firm loses the litigation and pays the opposing party, the company must cover the obligation. A warranty is yet another instance of a contingent duty. If a company’s product needs to be repaired or replaced, the company must have the finances to honour the warranty agreement.

How Liabilities Work?

A liability refers to an unfinished or unpaid duty between two parties. In the domain of accounting, a monetary debt or financial liability refers to an obligation that is primarily determined by past commercial transactions, events, sales, asset or service exchanges, or any other activity that will yield economic advantages in the future.

• Current Liabilities are typically categorised as short-term, they are expected to be settled within a period of 12 months or less.
• Non-Current Liabilities are categorised as long-term, indicating that they are expected to be settled over 12 months or more.

Liabilities are categorised as either current or non-current based on their temporal nature. They can encompass a forthcoming duty to provide a service to others (such as financing from banking institutions, individuals, or other businesses for a short or long period) or a past transaction that has resulted in an unresolved debt. The predominant obligations typically encompass the most substantial ones, such as bills payable and obligations payable. The above mentioned items are commonly found on the balance sheet of most organisations, as they are crucial to both present and future business. Liabilities play a crucial role in a firm since they are utilised to fund operations and cover significant expansions. Additionally, they have the capability to enhance the efficiency of transactions conducted between firms.  

Liabilities in Balance Sheet

Difference between Liabilities and Assets

Basis	Liabilities	Assets
Meaning	Liability refers to a commitment or obligation that a company assumes in order to sustain its activities without disruption. There exist liabilities that can be classified as either long-term or short-term. It is a financial obligation.	Assets are items that a company owns that will benefit it in the future. It is a financial resource that the company owns.
Formula	Liabilities = Assets – Shareholder’s Equity	Assets = Liabilities + Shareholder’s Equity
Types	Long-term (non-current) liabilities and current liabilities are the two types of non-current liabilities.	There are four categories of assets: current, non-current, intangible, and tangible.
Reporting	Liabilities are listed on the left side of the balance sheet.	Assets are listed on the right side of the balance sheet.
Examples	Accounts payable, bonds payable, accrued expenses, notes payable,loans payable, deferred revenue, lease liabilities.	Cash, patents, inventory, copyrights, goodwill, accounts receivable, equipment, prepaid expenses, investments.

Frequently Asked Questions (FAQs)

1. What impact does liability have on business?

Answer:

Debt (an obligation) can be utilised to finance daily operations and acquire additional assets. However, if liabilities grow excessively, it might be necessary to liquidate assets in order to repay those obligations. This may diminish the value of the company.

2. What are some liabilities that households or individuals bear?

Answer:

Similar to how assets and liabilities are separated in a balance sheet, the way in which a typical household operates can be interpreted in the same way. Included among the liabilities of the a majority of households are

• Bills outstanding
• Repayments of mortgage, rent, or property loans
• Interest on borrowed funds
• Student Loan
• Misc expenses

3. What are examples of personal liabilities?

Answer:

Personal liability might include any type of home or auto loan, student loans, or credit card debt that is past due.

4. Is deferred tax an obligation?

Answer:

Deferred taxes are taxes that are held but not payed for and can be found on a company’s balance sheet. It is documented as an obligation that must be paid in the future and emerges as a result of the time between the time when taxes are payable and the date they were recorded.

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

Answer:

Accounting formulae are used to calculate a company’s finances, which are broken down into assets, liabilities, and owner’s equity. It can help you determine a company’s genuine financial situation. The financial accounting formula for liabilities is as follows –

Assets = Liabilities + Equity

6. Should a company’s liabilities be greater than its assets?

Answer:

A company’s assets should always be greater than its liabilities. Higher liabilities suggest that an organisation is incurring significant debts and hence incurring higher interest payments. In the worst-case scenario, inability to repay can result in liquidation.