Concept of “Liability” in Accounting

Following Online Accounting Training Class on Accounting Liability will help you to understand:

  • What is Accounting Liability
  • Definition & Meaning of Liability
  • Types of Accounting Liability
  • Characteristics of Accounting Liability
  • Why the concept of Accounting Liability is Important
  • Concept of Current Liabilities with Example
  • Concept of Long Term Liabilities with Example

Liabilities are existing debts and obligations which are claimed against assets. What is size of the business is not a matter, every business whether it is small or large has to borrow money and purchase goods or services on credit for operating the business activities. Generally liabilities are considered as obligations to pay cash, transfer other assets, or provide services to any individual or company. A company may such liabilities like, the amounts of accounts payable which is owed by the company to suppliers, the amount of notes payable which is owed to banks or others, and the amount of mortgages payable which is owed for purchased property, such as equipments or buildings.  Liabilities should be reported in the balance sheet in their monetary value. The monetary amounts of liabilities help the company and the accountants to properly value the liabilities. Sometimes it may difficult for the company or the accountants to determine or quantify the amount of liabilities without their monetary value. The FASB (Financial Accounting Standards Board) has defined liabilities as “probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.”

Liability for any company must possess the following characteristics:

  • Possible future transfer of any good or services, use of cash, goods, or services are involved in the liabilities which is a present obligation
  • Liabilities are inevitable obligation for any entity or business.
  • The transactions or other economic events which are already occurred lead this debt or obligation.

The particular date or time on which the amount of liabilities are payable is most important features, as liabilities include future expenditure of assets or services. A company should pay the obligations in order to operate business activities.

Liabilities are categorized into two parts.

  • (1) Current liabilities and
  • (2) Long-term debt.

What is Current Liability:

Current assets referred the cash amount or other assets which are expected by the companies that, these current assets will to convert into cash, sell, or consume in the operational activities of business within one operating cycle or within a year. And current liabilities are the debt and obligations whose liquidation is rationally expected to pay from require use of existing current assets of the company or through the creation of other current liabilities. Generally current liabilities are the liabilities which are to be paid out of current assets and are payable within a short period of time, within one operating cycle of any economic entity. The company will pay the debt within one year or one operating cycle, whichever is longer because the operating cycle could be more than one year. If the debts or the obligations do not matched with the features of current liabilities then the debt will be referred as long-term liabilities. There prevail a significant relationship between current liabilities and current assets .Because the ability of any company to pay short-term debt could be evaluated through this relationship. If A company owned more current liabilities than current assets then the company may not be able to pay the current obligations .Current liabilities could be occurred from receiving goods or services on account which is payable at particular time or from receiving payment prior to delivering goods or services. Such as purchase of any goods or services on account or receipt of payment any services in advance.

Some of most common examples of current liabilities are Accounts payable, Notes payable, Current maturities of long-term debt, Short-term obligations expected to be refinanced, Dividends payable, Customer advances and deposits, Unearned revenues, Sales taxes payable, Income taxes payable, Employee-related liabilities and so on.

What is Long Term Liability:

Long-term liabilities are the debt and obligations that a company expects to pay after one year or one operating cycle. Basically Long-term debt includes those possible future sacrifices of economic benefits which arise from present obligations. Long term liabilities are not payable within one year or one operating cycle of the company, whichever is longer. The long-term debt are reported by any company maturing after one year as a single amount in the balance sheet and show the details of the debt in the financial statements of the company. Generally, long-term debt has certain restrictions that provide shelter to both lenders and borrowers. The agreement often includes, interest rate, the payable date(s), call provisions, property pledged as security, the amounts authorized to be issued, sinking fund requirements, working capital and dividend restrictions, and limitations associated with the assumption of additional debt. Companies may illustrate these features in the financial statements. If companies add more debt to the capital structure or the level of obligations reaches to high stage, many bondholders also suffer significant losses, besides having these agreements.

Bonds payable, long-term notes payable, mortgages payable, pension liabilities, and lease liabilities are the common examples of long-term liabilities.