A liability is a financial obligation that a person or company is responsible for, often represented as a sum of money. These obligations are settled over time through the transfer of various economic benefits like money, goods, or services.
Liabilities are recorded on the right side of the balance sheet and include items such as loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses. They are contrasted with assets, which represent things you own or are owed.
Key Takeaways
- A liability generally refers to something owed to another party.
- It can mean financial debts or legal obligations.
- Companies book liabilities opposite assets in accounting.
- Current liabilities are short-term debts due within one year.
- Long-term liabilities are obligations not due for more than one year.
How Liabilities Work
In the business world, liabilities represent an obligation between two parties not yet settled. Financial liabilities, more specific to accounting, stem from previous business transactions or events where economic benefits must be provided at a future date. They are categorized into current (short-term) and non-current (long-term) liabilities.
Liabilities serve to finance operations and facilitate business transactions. For example, a restaurant that owes money to a wine supplier for a recent delivery has a liability, while the supplier considers the owed money an asset.
Types of Liabilities
Liabilities are categorized into current and non-current ones based on their due dates. Current liabilities are short-term, expected to be settled within a year. Examples include payroll expenses, accounts payable, and monthly utilities. On the other hand, non-current liabilities, such as long-term debt and lease obligations, extend beyond one year.
Current Liabilities Examples
- Wages Payable: Amounts earned by employees but not yet paid.
- Interest Payable: Interest on short-term credit purchases.
- Dividends Payable: Amount owed to shareholders after a dividend declaration.
- Unearned Revenues: Future goods/services owed after advance payment.
- Liabilities of Discontinued Operations: Financial impact of divested business sectors.
Non-Current Liabilities Examples
- Long-Term Debt: Debt obligations maturing beyond one year.
- Warranty Liabilities: Estimated costs for product warranties.
- Contingent Liabilities: Potential liabilities dependent on future events, like lawsuits.
- Deferred Credits: Revenue collected but not yet earned.
- Post-Employment Benefits: Benefits accrued for employee retirement.
Liabilities vs. Assets
Assets encompass everything a company owns or is owed, spanning tangible (buildings, machinery) and intangible (accounts receivable, patents) items. The formula representing the relationship between assets, liabilities, and equity is:
Assets = Liabilities + Equity
It can also be rearranged to highlight the equity position:
Liabilities = Assets - Equity
Liabilities vs. Expenses
Expenses are the costs a company incurs to generate revenue, listed on the income statement, whereas liabilities are obligations listed on the balance sheet. Notably, expenses are deducted from revenues to calculate net income, while liabilities represent future financial commitments.
Practical Example of Liabilities
Consider the example of AT&T’s 2020 balance sheet. The balance sheet distinguishes between current (short-term) liabilities and long-term (non-current) liabilities. The listing of liabilities not only helps assess the financial health but also serves as a basis for more strategic decision-making.
FAQs About Liabilities
How Do I Know If Something Is a Liability?
A liability is borrowed money, an owed debt, or an obligation to another party. It may be real (specific bills) or potential (possible lawsuit).
How Are Current Liabilities Different From Long-Term Ones?
Current liabilities are due within a year and paid using current assets. Non-current liabilities are due after one year, commonly including long-term debts.
How Do Liabilities Relate to Assets and Equity?
Through the formula, assets equal liabilities plus equity, demonstrating that any increase in liabilities, if not matched with assets, affects the equity value.
What Is a Contingent Liability?
Contingent liabilities depend on future outcomes, such as potential lawsuits, product warranties, or recall claims.
What Are Examples of Liabilities for Individuals?
For individuals, liabilities include tax obligations, utility bills, mortgages, loan payments, and other debts. Pre-paid work commitments also count as liabilities.
By comprehensively understanding and managing liabilities, businesses and individuals can better navigate financial landscapes, optimize their balance sheets, and achieve strategic financial stability.
Related Terms: assets, equity, balance sheet, current liabilities, non-current liabilities, expenses.
References
- U.S. Small Business Administration. “Get Business Insurance”.
- AT&T. “2020 Annual Report”.
