What Is A Liability?
A Liability is the obligation of a Company or Entity to repay a Debt or Expense due to current or past operations of the company. To make that simple, A Liability is the obligation of a company to repay a debt. Liabilities are settled over time by the transaction of money, goods or services.
There are multiple different Liabilities that a company can have.
Short Term Liabilities called Current Liabilities,
Fixed/Long term Liabilities
Liabilities and Assets have a direct relationship in a company. A retail store that sells shorts has a Liability with the manufacturer of the shirts they sell (accounts payable) but the manufacturer has an Asset of Accounts Receivable for the owed money. To get a better understanding of a Liability;
Liabilities have one or more of the following characteristics.
- An event or transaction that has already occurred obligating the company or entity such as a contract.
- A duty or responsibility of a Company for a transaction or payment of goods or services.
- Any borrowing of Assets from Banks or Lenders for improving the business.
Current Liabilities are liabilities that will be paid for within 12 months. Current liabilities usually make up the biggest portion of a company’s liabilities. Current liabilities are directly related to everyday transactions as well as some portions of Long Term Liabilities. Accounts Payable will usually be the largest portion of a company’s Current Liabilities because it encompasses the day to day operations within the company. Accounts payable can include things such as goods and services supplies or raw materials.
Some of the most common Current Liabilities are:
Income Tax Payable-
Income Tax Payable is the amount of tax accrued through the year for income earned by a company or corporation that they are obligated to pay to the government from sales of goods or services.
Interest Payable is the accrued interest on debts or Accounts payable. If a company has a short term loan for daily operations the interest on the loan is a Liability for money owed. Also, Interest in Accounts Payable will be in this Liability category.
Sales Tax Payable-
During daily operation of sales, the tax required to be paid to the government from the price of goods or services.
Customer Deposits are a Liability when needing to be repaid. For example, when you deposit cash into a Bank the Bank adds your deposit as a Liability because they are obligated to repay you your deposit. The bank also adds your deposit directly to their Assets as well because they have the cash from your deposit.
Dividends Payable is the amount a company will issue to its Stock/Shareholders at a given time. Dividends can come from money or services earned by a company and are spread through its Stock/Shareholders at a specified amount per share.
Accrued Wages is the amount the company is liable to pay for services of their employees that they have not yet received. Since a lot of companies pay their employees every week or biweekly the amount of Accrued Wages will be changing constantly.
Accounts Payable (AP)-
Accounts Payable (AP) is the amount payable or owed from everyday transactions that will be paid within 12 months. Accounts Payable will include any transaction for goods or services from other companies or entities and be repaid with assets such as cash.
Short Term Debt-
Short Term Debt is debt that will be paid within the 12-month window this can include things such as Overdraft on accounts or Operational Loans set with a repayment term within 12 months or less.
Maturities Of Non-Current Debt-
These Liabilities are the accumulative amount needing to be paid for long Term Liabilities such as a Mortgage. The payments every month toward the Mortgage are Maturities Of Non-Current Debt. This is also the case for Long Term Loans such as vehicle payments.
Fixed/Long Term Liabilities
A Fixed/Long Term Liability is a liability that will be paid for through Assets for longer than 12 months. These types of Liabilities range from larger loans or expenditures related to the operation of a company. A mining company will incur a large amount of Fixed/Long Term Liabilities while testing and going through operations to set up a mine. Once the mine is up and operational the Long Term Liabilities are being paid for from the operations of the mine. Some other examples of Fixed/Long Term Liabilities are:
Deferred Tax Liabilities-
A Deferred Tax Liability is simply the amount of tax that a company is Liable to repay but has yet to do so. When a company pays tax on goods or services the deferred tax is the difference between the tax on the sale and the year taxes for gross income. A company can “underpay” which would be the Deferred Tax Liability
Deferred Compensation is an arrangement with employees to pay a portion of the money owed at a later time. Deferred Compensation can include Pensions, Retirement Plans or Vacation Pay.
The Pension Liability is the amount a company is liable to pay to employees after retirement for services while employed.
Long Term Loans-
Long Term Loans includes all loans with greater time than 12 months. A Mortgage or Vehicle loan lasting more than 12 months will be a Long Term Loan. The overdraft will not be a long term loan because it is expected to be paid for within the 12-month time frame.
Many companies pay for all or a portion of Healthcare Benefits to employees. The amount that is paid every year can be a Fixed/Long Term Liability because it can be a reoccurring payment even through the retirement of the employees.
Liabilities In Accounting
Accounting for Liabilities in financial statements is a big portion of what a company needs to see to understand how liquid their company is. A business’s Balance Sheet is one of the most fundamental parts of accounting. On the Balance Sheet, assets and liabilities are compared and given total values. There are also several ratios that use the value of your liabilities to express different levels of liquidity in a company such as:
- Current Ratio- Current Assets Divided By Current Liabilities
- Quick Ratio- Current Assets Minus Inventory Divided By Current Liabilities
- Cash Ratio- Cash or Equivalents of Cash Divided By Current Liabilities
In All 3 of these ratios the higher the ratio value the more liquid the company.
The Difference Between An Expense And A Liability
An expense is a cost derived through the everyday workings of a company to generate revenue. An expense is directly related to income which is why expenses are expressed on an income statement rather than liabilities which are expressed on a business’s balance sheet.
An example of the difference would be; if you owned a retail store in which you sold t-shirts. If you purchased the property and had a Mortgage, your Mortgage would be a liability but the water bill for the property would be an expense every month.
Contingent Liability is a potential liability based on uncertain future events. A Contingent liability doesn’t always have to be presented in the values expressed on the balance sheet. There are certain rules that must be met and even if the Contingent Liability isn’t expressed in the balance sheet there will usually be a footnote to properly inform Financial Statement readers of the possible Liability.
A Contingent Liability will be an estimated value of the potential cost. Some of the most common Contingent Liabilities are; Lawsuits and Product Warranties. If a company has a pending lawsuit the potential cost related to the lawsuit would be a Contingent Liability because the outcome of the lawsuit is yet to be determined. Also, the cost associated with any product warranties is estimated because the potential cost can’t be known.