In its simplest form, your balance sheet can be divided into two categories: assets and liabilities. Assets are those items of your business that can bring future economic benefits. Liabilities are what you owe to other parties.
In short, assets put money in your pocket and liabilities take money out of you! So, what are liabilities and examples of liabilities? Let’s take a closer look at everything you need to know.
What is Liability?
A liability is simply a debt or obligation. Most people have liabilities in their day-to-day lives: car payments, rent, and credit card bills. In corporate finance, the liabilities are similar, just on a much larger scale.
A company’s liabilities can include long-term borrowings to fund operations, money owed by a company to suppliers, and leases for warehouse space. When a company must pay someone or something, it is a liability.
Liabilities listed on the right side of the balance sheet include loans, trade payables, mortgages, deferred income, bonds, guarantees, and accrued expenses.
Liabilities can be compared to assets. Liabilities refer to things you owe or borrow; Assets are things you own or owe.
Examples of Liabilities
Following are the Examples of liabilities:
- Bank debt
- Mortgage debt
- Money owed to suppliers (accounts payable)
- Wages owed.
- Taxes owed.
1. Bank Debt
Bank debt is a long-term liability that a company incurs by borrowing money from its bank, according to BBC. It appears on the balance sheet under liabilities as part of any monies owed by the company to its creditors.
Businesses use bank debt to pay for long-term assets, such as land, buildings, and equipment, or to add more cash to their working capital to cover ongoing, short-term expenses (current liabilities). Details of bank debt and other long-term liabilities are set out in the notes to the financial statements that accompany the balance sheet.
As a long-term liability, bank debt is payable for more than 12 months, which often means a company must make payments over many years to pay off the balance.
2. Mortgage Debt
Mortgage debt is a type of loan used to buy or maintain a home, land, or other type of property. The borrower agrees to make payments to the lender over time, typically in the form of a series of periodic payments divided into principal and interest. The property then serves as collateral to secure the loan.
A borrower must apply for a mortgage through their preferred lender and ensure they meet several requirements, including minimum creditworthiness and down payments. Mortgage applications go through a rigorous underwriting process before reaching the closing stage. The types of mortgages vary depending on the needs of the borrower, such as conventional loans and fixed-rate loans.
3. Money owed to suppliers (accounts payable)
Accounts Payable (AP) is an accounting term used to describe the money owed to its vendors/suppliers who have provided goods or services to the company on credit.
The sum of all outstanding payments that an organization owes to its suppliers is recorded as a payable balance on the company’s balance sheet, while the increase or decrease in total AP from the prior-year period is recorded on the cash flow statement.
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4. Wages owed.
Wages payables refer to an organization’s liability for wages earned by but not yet paid to employees, according to Accountingtools. The balance on this account is settled, as a rule, at the beginning of the following reporting period, when wages are paid to employees.
A new wage liability is created later in the following period if there is a gap between the date employees are paid and the end of the period.
When a company pays salaries to its employees at the end of a reporting period, there is no wage liability because the salary payments reflect the amount the employees have earned up to the payment date.
5. Tax liability
Tax liability is the payment that an individual, corporation, or other legal entity owes to a federal, state, or local tax authority, according to Investopedia.
In general, you are subject to tax when you receive income or gains from the sale of an investment or other asset. You may have no income tax liability if you do not meet the income requirements for the tax return.
Types of Liabilities
Liabilities are typically categorized by expiry or due date: current liabilities are urgent debts and obligations, while Non-Current (Long-Term) Liabilities are important but do not require immediate action.
Current (Near-Term) Liabilities
Current liabilities are short-term debts and obligations that are due within one year. Some common examples of liabilities are:
- Wages Payable: The total amount of accrued income earned but not yet received by the worker. Since most companies pay their employees every two weeks, this liability changes frequently.
- Short-term loans: Businesses, like individuals, often use credit to purchase goods and services and finance them over short periods. This represents the interest to be paid for short-term credit purchases.
- Dividends Payable: For companies that have issued shares to investors and pay a dividend, this represents the amount owed to shareholders after the dividend declaration. That period is about two weeks, so this liability typically arises four times a year until the dividend is paid.
- Unearned Revenue: This is the company’s obligation to deliver goods and/or services at a later date after prepayment. This amount will be reduced in the future by an offsetting entry once the goods or services have been delivered.
- Discontinued Operations Payables: This is a unique liability that most people overlook but should take a closer look at. Businesses have an obligation to consider the financial implications of an operation, division, or business that is currently for sale or has recently been sold. This includes the financial impact of a product line that is being or has recently been retired.
- Commercial Paper: Unsecured fixed-rate notes used by companies to fund very urgent liabilities such as payrolls.
Non-Current (Long-Term) Liabilities
Non-Current or long-term liabilities are debts and obligations that fall due in the future but not in the next year. Some types of long-term liabilities are:
- Warranty Liability: Some liabilities are not as accurate as AP and must be estimated. This is the estimated time and money that can be spent repairing products when a warranty is arranged. This is a common liability in the automotive industry as most cars come with long-term warranties which can be costly.
- Deferred Loans: This is a broad category that can be classified as short-term or long-term depending on the specifics of the transactions. These credits are basically income received before it is recorded as earned in the Profit and Loss Account. This may include customer advances, deferred revenue, or a transaction where credits are owed but not yet considered revenue. Once revenue is no longer deferred, that item is reduced by the amount earned and becomes part of the company’s revenue stream.
- Post-employment benefits: These are benefits that an employee or family member may receive upon retirement and are recognized as a long-term liability when they accrue. In the AT&T example, this accounts for half of total long-term debt, just behind long-term debt. In the face of rapidly expanding healthcare and deferred compensation, this burden cannot be overlooked.
- Unamortized Investment Tax Credit (UITC): This represents the net amount between the historical cost of an asset and the amount that has already been written off. The unamortized portion represents a liability but only represents a rough estimate of the asset’s fair value. To an analyst, this provides some detail about how aggressive or conservative a company is in its depreciation methods.
- Contingent Liabilities: Contingent liabilities are a special type of liability that may arise during a business, depending on the outcome of an event that may occur in the future. In accounting standards, contingent liabilities are only recognized as potential or probable liabilities when there is a 50% probability of occurrence, and the amount of the liability can be reasonably estimated. Some examples of contingent liabilities are Product Warranties and Lawsuits.
How Do I Know If Something Is a Liability?
Liability is something borrowed, owed to, or obligated to another person. It can be real (e.g., a bill that needs to be paid) or potential (e.g., a possible lawsuit).
Liability is not necessarily a bad thing. For example, a company may take on debt (a liability) to expand and grow its business. Or an individual can take out a mortgage to buy a home.
For most households, liabilities include taxes due, bills owed, rent or mortgage payments, loan interest and principal payments owed, etc. If you receive an advance payment for the provision of work or service, the work owed can also be construed as a liability.