Liabilities in Accounting

Liabilities are the obligation or debt on the company, individual person, or an organisation which has to pay to the outsiders from which debt had been taken for the business purposes. It is the claim of the outsiders to the total assets of the business. Liability is the value which has to pay to the creditors within a period of time. Liabilities are paid from the current assets in the business or from another current liability. Liability is the present legal obligation which is the result of past events.

Liabilities in Accounting

Liabilities are settled over time by transferring the economic benefits such as money, goods or services. Liability generally refers to the state of being responsible for something.

Example of liabilities:

  • Accounts payable
  • Expenses payable
  • Interest payable
  • Salaries payable
  • Bonds payable
  • Loans
  • Mortgage payable
  • Bills payable
  • Long-term loans
  • Short-term loans

The most common liabilities are accounts payable and bonds payable.

TYPES OF Liabilities:

  1. Current liabilities (Short-term liabilities)
  2. Non- current liabilities (Long-term liabilities)
  3. Contingent liabilities

CURRENT LIABILITIES

Current liabilities are also called short-term liabilities as they are the obligations or debts which have to repaid within twelve months or a year. In this obligation management deeply watches company to make sure that the company can repay the obligation within the time period given to them or not.

Examples of liabilities:

  • Short-term loans Short-term loans are the loans which are taken and to be repaid in the short period i.e. within twelve months or a year.
  • Bills payable – These are the bills which include utility bills such as electricity bill, water bill, maintenance bill which are payable.
  • Interest payable – It is the interest amount which has to be paid to the lenders on the money owned usually to the banks.
  • Accounts payable – These are the payable to the creditors or suppliers as the return for something received i.e. money, goods or services.
  • Current maturities – Current maturities are the long-term debt whose portion of a company’s liability that is going to mature and due in the next twelve months.
  • Accrued payable – These are the expenses such as the salaries which have to be paid to the employees in the future.

KEY RATIOS IN CURRENT LIABILITIES

  • The current ratio: current assets divided by current liabilities.
  • The quick ratio: current assets minus inventory divided by liabilities.
  • The cash ratio: cash & cash equivalents divided by current liabilities.

loans CURRENT LIABILITIES

NON-CURRENT LIABILITIES

Non-current liabilities are also known as Long term liabilities. It is a source of the company’s long term financing.

Examples of Non-current liabilities:

  • Long-term loans – These are the loans which have to be repaid in the longer period usually more than a year.
  • Bonds payable – These are the debt generally issued by government, hospitals, cooperation in which bondholder will pay interest every six months.
  • Capital lease – It is an agreement made between the owner and the person for the temporary use of an asset. In simple words, you can say that it is a contract between the owner and the person to transfer the ownership rights to the lessee after the completion of the lease period.
  • Deferred income tax – These are the taxes which are due for the current period that a company will ultimately or later pay on its taxable income. These taxes are a rise in temporary liability.

CONTINGENT LIABILITIES

This is the liabilities which result in the outcome of a future event. This type of liabilities depends on the success or failure of future events. In simple words, you can say that the liabilities which may or may not occur.

  • Product’s warranty – A warranty is a promise given on a product for a particular period of time and if the product gets damaged then the company will liable to it and need to pay for that.
  • Potential lawsuits – This arises when a party fails to pay the debt in time and a person gives a guarantee for another party.

DEBIT VS CREDIT FOR LIABILITIES

Debit means what comes in while credit means what goes out but in accounting, their definitions changed. In business, the debit means the money goes out of the account whereas the credit means money comes in the account. Business accounting includes a double-entry system. In balance sheet or book-keeping, the debit is recorded on the left side whereas the credit is recorded on the right side. In business, accounting is affected by the two facts i.e, debit (receiver) & credit (giver). It means that every transaction affects two accounts. Sometimes in the same funds used as a credit in one area & used as a debit in other. So, debits and credits for the liabilities are:

  • liabilities are recorded as a debit when they decreased.
  • liabilities are recorded as a credit when they increased.

OR

  • liabilities decreased – debited; and
  • liabilities increased – credited.

LIABILITY Synonms

  • A source of liability: balance, burden, account, debit, responsibility, arrears, pledge, chance, involvement, contract, lease.
  • The state of being liable: obligation, indebtedness, owing, accountability, susceptibility.
  • In terms of disservice: disadvantage, burden, drawback, inconvenience, minus, drag.
  • The state of being legally responsible: accountability, culpability, obligation, onus.
  • In terms of accountability: responsibility, culpability, liability.
  • Something that is hard to bear: trouble, worry, trial, stress, strain, anxiety.
  • Something which is owed such as money: arrearage, debt, obligation, indebtedness.

 

Different terms used in liabilities are

Debt or Obligations:

This is the amount taken from the outsider or from other sources for business purposes or to run the business activities. It is given to the company for a given period of time. So, the company has to return it on the time. Company has to pay interest on the debt at regular intervals, lenders lend funds to the borrower by taking a promise from the borrower to pay interest on the debt.

  • If the debt is to pay within a year then it will be called short-term debt & it will record in short-term debt account.
  • If the debt is to pay in more than a year then it will be called long-term debt & will be recorded in long-term debt account.
  • If the debt is in the form of credit cards then it is called account payable & will be recorded in account payable module in accounting software.

Owner’s equity/Shareholder’s equity/Stockholder’s equity:

It is a liability arises when a person starting a business, the owner fund the business for various business operations. In this liability, the business and its owner both are separate entities. So, the business is the entity which receives the fund from their owner while the owner is the entity who issues the fund to the business. It is also called shareholder’s equity, stockholder’s equity.

Bonds:

These are the debt generally used by the companies, public authorities, and states, etc. Bonds are issued by the government, hospitals, cooperation to the companies and other authorities to achieve their goals. In simple words, you can say that it is a loan issued by an investor to a holder and a promise to repay. Bonds are also referred to as the fixed interest instrument as they paid fixed interest rate or coupon rate to the borrower (debtholder). The most common bonds are municipal bonds and government bonds.

Liability Account

It is a general ledger account which is used by a company to record its debt, obligations, customer deposits and customer prepayments, deferred income tax, etc. Companies used them to keep track of their liabilities in a proper manner.

Liability products & Asset products in Banking

Liability products:

Banks provide a number of liability products to the customers. These products are referred to as the “liability products” as they show the liability of a bank. These products are usually indicated by using the word “deposit” product. These products include saving accounts, checking, money market accounts, etc.

In simple words, you can say that these are the products in which a bank is liable to pay interest on the deposit made by the customer. Hence, a deposit is a liability product for the customer as the bank has to pay interest on the deposit.

Examples of liability products:

  • Savings deposit/accounts
  • Current deposit/account
  • Fixed deposit
  • Mutual funds
  • Insurance

Asset products:

If a bank gives loan to the customer then, it is an asset for the bank. A loan is an asset for the bank because the bank can earn interest income by hand-over loan to the customer.

In simple words, you can say that the customer is liable to pay interest on the loan to the bank.

Examples of asset products:

  • Home loans
  • Vehicle loans
  • Educational loans
  • Personal loans
  • Credit card

Liability insurance

Insurance refers to the protection from financial loss. People buy insurance to protect themselves from a financial loss such as money resulting from injuries and damage to people/or property. A person who buys insurance is known as the insured or the policyholder whereas the entity which provides insurance is known as the insurer, insurance company, etc.

Liability insurance includes the following:

  • provides financial protection to the insured party.
  • insurance company, the insurer gives promise to the insured party for the duty of care.
  • it covers the legal costs and payouts if the insured party would be found liable.
  • it includes the “premium” which has to pay every month by the insured party.
  • the insured party receives a contract, called the insurance policy which shows details about the terms and conditions of the policy.

Examples of liability insurance:

  • Employer’s liability and worker’s compensation
  • Product liability insurance
  • Commercial liability insurance
  • Indemnity insurance
  • Umbrella liability policies.

Liabilities vs  Assets

Assets mean the value, a thing, or property which has been owned by a company from where the company can get economic benefit in the future. Simply, you can say that which helps you in generating future income or cash flow. The only thing which is useful in generating income is called Assets, if something which does not results in generating money and it becomes the cause for the loss of the money from your income or pocket is called liability.

Liability is the legal responsibility in which you have to pay the money for damage or injury, maintenance or repair for something. Liabilities cause those expenses that you need to fulfill.

Liabilities to Asset ratio

It is the debt ratio calculated by dividing the total debt with total assets. It is a financial ratio which shows that how much company’s assets are financed or provided by debt. This ratio also represents how much a company has developed and got their assets over time. It includes:

  • higher debt ratio means more money a company has to pay to its creditors.
  • lower debt ratio means less money a company has to pay to its creditors.

The formula for liability to asset ratio is:

Debt ratio calculation= Total liabilities or Total debt / Total assets

OR

The formula for Total debt to Total assets is:

TD/TA formula = (Short-term debt + Long-term debt) / Total assets

Liability vs Equity

Liability is the debt or obligation which is owed by the company from the outsiders rather than the owner.

Equity is the capital‘s or owner’s financial share of the company. It is also called net worth because it represents whatever left after you subtract your total liabilities from your total assets.

According to the accounting equation:

Assets = Liabilities + Owner’s Equity

So, the formula for calculating equity is:

Assets – Liabilities = Owner’s Equity

Liabilities to equity ratio or Debt ratio

It is the debt ratio calculating by dividing the total liabilities from the total shareholder’s equity. It is used to know how much leverage a company is using. It includes:

  • higher debt ratio means a higher risk for the bank as the company may not be able to generate sufficient money to fulfill its debt.
  • if the debt ratio is higher than the loan application will be declined by the bank.
  • lower debt means lower risk for the bank.
  • If the debt ratio is lower than the loan application will be approved by the bank.

Debt ratio formula:

Debt/Equity = Total liabilities / Total shareholder’s equity

OR

D/E = (Short-term debt + Long-term debt + Other fixed payments) / Shareholder’s equity

Difference between the liabilities & the expenses

Liabilities are the legal obligation or debt owed by the company and are listed on the balance sheet whereas the expenses are the costs of company’s operation or services from which company has already taken benefit and are listed on the company’s income statement.

Liability verification

Liability verification is a process of making accurate information on liabilities. This process proves the truth about liabilities.

This verification process includes verifying:

  • the existence of the liabilities shown in the balance sheet.
  • accuracy of the money amount of that liabilities.
  • outstanding expenses and accounts payable.
  • to confirm the ownership of the item.
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