Liabilities in Accounting: Definition & Examples

Liabilities are incurred in order to fund the ongoing activities of a business. Examples of liabilities are accounts payable, accrued expenses, wages payable, and taxes payable. These obligations are eventually settled through the transfer of cash or other assets to the other party.

For example, in most cases, if a wine supplier sells a case of wine to a restaurant, it does not demand payment when it delivers the goods. Rather, it invoices the restaurant for the purchase to streamline the drop-off and make paying easier for the restaurant. A liability is something a person or company owes, usually a sum of money. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services. Current liabilities are used as a key component in several short-term liquidity measures.

Current (Near-Term) Liabilities

Of the preceding liabilities, accounts payable and notes payable tend to be the largest. A liability account is used to store all legally binding obligations payable to a third party. Liability accounts appear in a firm’s general ledger, and are aggregated into the liability line items on its balance sheet. Liabilities are aggregated on the balance sheet within two general classifications, which are current liabilities and long-term liabilities. You would classify a liability as a current liability if you expect to liquidate the obligation within one year. If there is a long-term note or bond payable, that portion of it due for payment within the next year is classified as a current liability.

For a company this size, this is often used as operating capital for day-to-day operations rather than funding larger items, which would be better suited using long-term debt. As a practical example of understanding a firm’s liabilities, let’s look at a historical example using AT&T’s (T) 2020 balance sheet. The current/short-term liabilities are separated from long-term/non-current liabilities on the balance sheet. We use the long term debt ratio to figure out how much of your business is financed by long-term liabilities. If it goes up, that might mean your business is relying more and more on debts to grow. Liabilities in accounting are money owed to buy an asset, like a loan used to purchase new office equipment or pay expenses, which are ongoing payments for something that has no physical value or for a service.

For example, if a company has more expenses than revenues for the past three years, it may signal weak financial stability because it has been losing money for those years. Liabilities must be reported according to the accepted accounting principles. The most common accounting standards are the International Financial Reporting Standards (IFRS).

What is a liability?

For example, if a company takes on a bank loan to be paid off in 5-years, this account will include the portion of that loan due in the next year. You gain a liability every time you borrow rather than pay outright. Borrowing includes paying with a credit card unless you pay back the money within the month.

• The most liquid of all assets, cash, appears on the first line of the balance sheet.
• For example, an entity routinely records provisions for bad debts, sales allowances, and inventory obsolescence.
• To operate on a cash-only basis, you’d need to both pay with and accept cash—either physical cash or through your business checking account.
• Please note that liabilities are not the same thing as expenses, even though they sound similar.
• Examples of liabilities are accounts payable, accrued expenses, wages payable, and taxes payable.

If a contingent liability is only possible, or if the amount cannot be estimated, then it is (at most) only noted in the disclosures that accompany the financial statements. Examples of contingent liabilities are the outcome of a lawsuit, a government investigation, or the threat of expropriation. Examples of liabilities are accounts payable, accrued liabilities, accrued wages, deferred revenue, interest payable, and sales taxes payable. An expense is the cost of operations that a company incurs to generate revenue.

Long-Term Liabilities

The money owed for the first year is listed under current liabilities, and the rest of the balance owing becomes a long-term liability. This can give a picture of a company’s financial solvency and management of its current liabilities. When a company determines that it received an economic benefit that must be paid within a year, it must immediately record a credit entry for a current liability.

However, many countries also follow their own reporting standards, such as the GAAP in the U.S. or the Russian Accounting Principles (RAP) in Russia. Although the recognition and reporting of the liabilities comply with different accounting standards, the main principles are close to the IFRS. It is possible to have a negative liability, which arises when a company pays more than the amount of a liability, thereby theoretically creating an asset in the amount of the overpayment. Janet Berry-Johnson, CPA, is a freelance writer with over a decade of experience working on both the tax and audit sides of an accounting firm. She’s passionate about helping people make sense of complicated tax and accounting topics. Her work has appeared in Business Insider, Forbes, and The New York Times, and on LendingTree, Credit Karma, and Discover, among others.

Long-term debt, also known as bonds payable, is usually the largest liability and at the top of the list. These are any outstanding bill payments, payables, taxes, unearned revenue, short-term loans or any other kind of short-term financial obligation that your business must pay back within the next 12 months. Different types of liabilities are listed under each category, in order from shortest to longest term. Accounts payable would be a line item under current liabilities while a mortgage payable would be listed under long-term liabilities. Accrued liabilities and accounts payable (AP) are both types of liabilities that companies need to pay. Although they aren’t distributed until January, there is still one full week of expenses for December.

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Along with the shareholders’ equity section, the liabilities section is one of the two main “funding” sources of companies. Accrued liabilities only exist when using an accrual method of accounting. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Where “equity” represents the total stakeholder’s equity of the company. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. A liability is something that is borrowed from, owed to, or obligated to someone else.

Accounts payable is typically one of the largest current liability accounts on a company’s financial statements, and it represents unpaid supplier invoices. Companies try to match payment dates so that their accounts receivable are collected before the accounts payable are due to suppliers. Analysts and creditors often use the current ratio, which measures a company’s ability to pay its short-term financial debts or obligations.

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Current liabilities are due within a year and are often paid for using current assets. Non-current liabilities are due in more than one year and most often include debt repayments and deferred payments. According to the accounting equation, the total amount of the liabilities must be equal to the difference between the total amount of the assets and the total amount of the equity. By far the most important equation in credit accounting is the debt ratio. It compares your total liabilities to your total assets to tell you how leveraged—or, how burdened by debt—your business is.

Auditors typically purchase professional liability insurance to protect themselves from any monetary damage arising from such situations. This additional cost for the accountant can often raise the cost of the audit. This line item includes all of the company’s intangible fixed assets, which may or may not be identifiable. Identifiable intangible assets include patents, licenses, and secret formulas. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.

It can be real (e.g. a bill that needs to be paid) or potential (e.g. a possible lawsuit). Liability may also refer to the legal liability of a business or individual. For example, many businesses take out liability insurance in case a customer or employee sues them for negligence. Liabilities refer to things that you owe or have borrowed; assets are things that you own or are owed. This post is to be used for informational purposes only and does not constitute legal, business, or tax advice.

Each liability is also listed under a category according to what it is. The balance sheet includes records of assets, equities, and liabilities. A contingent liability is an obligation that might have to be paid in the future, but there are still unresolved matters that make it only a possibility and not a certainty.

Inventory includes amounts for raw materials, work-in-progress goods, and finished goods. The company uses this account when it reports sales of goods, generally the notion and peculiar features of payroll and payroll taxes under cost of goods sold in the income statement. The Accounting Equation establishes the relationship between the financial activities of a business.