What are Liabilities in Accounting
A liability is something that an individual or corporation owes, normally a monetary amount. Liabilities are resolved over time by transferring economic benefits such as money, commodities, or services.
In general, a liability is an unfulfilled or unpaid obligation by one party and another. A financial liability is also an obligation in the field of accounting, but it is more characterized by previous corporate purchases, activities, acquisitions, sharing of goods or resources, or something that will have economic value at a later date.
Importance of Liability:
Liabilities (money owed) aren’t really a bad thing. Some loans are obtained to purchase new properties, such as tools or vehicles that assist a small business in operating and growing.
However, too much responsibility can be financially damaging to a small enterprise. Owners should keep an eye on their debt-to-equity and debt-to-asset ratios. Simply placed, a company’s reserves (items of financial value) should be sufficient to pay off its debt.
Types of Liability:
Liabilities are classified into two types: current and non-current.
Current Liabilities or Short-term Liabilities:
Liabilities that must be settled within a year are referred to as current liabilities. Employee wages, utilities, equipment, and invoices are examples of current liabilities. Current liabilities are also called short-term liabilities.
Example of Current Liabilities:
Bank account overdraft
Income taxes payable
Short term loans
Non-current or Long-term Liabilities:
Non-current liabilities are also known as long-term liabilities. They are commitments that do not have a maturity period within a year.
Example of Non-current Liabilities:
• Bonds payable
• Long-term notes payable
• Deferred tax obligations
• Mortgage payable
What are Contingent Liabilities?
A contingent liability is one that can arise as a result of the consequences of an unknown potential case. If the contingency is probable and the size of the liability can be accurately calculated, a contingent liability is reported. If all conditions are met, the liability will be reported in a footnote to the financial statements.
Example of Contingent Liabilities:
Let us look at contingent liabilities from the perspective of a company. Your business could be in the midst of a lawsuit, and the council believes that the opposing side has a good argument that may result in $10 million in damages.
In any case, the amount will be reported as a contingent liability on the company’s balance sheet. On the other side, whether the prosecutor or legal department believes that the opposing party may not have a good argument. They will warn the company not to have any clause for contingent liabilities.
When the probability of a contingent liability is minimal, no journal or even a disclosure in the books of accounts is required.
What are the Three Main Characteristics of Liabilities in Accounting?
A liability has three basic characteristics:
- It embodies a present obligation or commitment to one or more organizations that involves settlement by potential future transition or use of assets at a predetermined or determinable date, on the occasion of a specified event, or on-demand.
- The obligation or liability binds a certain individual, giving it little to no flexibility to avoid possible loss.
- The transaction or other occurrence that obligates the individual has already happened
Difference Between an Expense and a Liability:
An expense is the cost of operations incurred by a company in order to raise revenue. Expenses, unlike assets and liabilities, are linked to earnings and are both reported on a company’s financial statement. In a summary, costs are used to compute net profits. Net income is calculated by subtracting revenues from expenditures.
For example, if a business has had more expenses than sales for the past two years, it may indicate a lack of financial security because it has been losing money over that period.
Expenses and liabilities cannot be confused with each other. One appears on a company’s balance sheet, and the other is on the income statement. Expenses are the costs of running a business, while liabilities are the commitments and loans owed by the business. Expenses should be charged in cash right away, or payments can be deferred, resulting in debt.
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