In a business scenario, a liability is an obligation payable to a third party. It may or may not be a legal obligation and arises from transactions and events occurred in the past. It is usually payable to an external party (e.g. lenders, long-term loans).
There are mainly three types of liabilities except for internal liabilities. Current liabilities, Non-Current liabilities & Contingent Liabilities are the three main types of liabilities. The settlement of a liability is expected to result in an outflow of funds from the company.
Total Liabilities are always equal to the Total Assets.
(Capital + Liabilities) = Assets
Accounting for a Liability Account
While dealing with a liability account it is important to know that it would always carry a credit balance.
As per the modern classification of accounts or American or Modern Rules of accounting an increase in liability is credited whereas a decrease is debited.
Liabilities Shown in Financial Statements
Liabilities are shown on the left-hand side of a vertical balance sheet. They would always equal to the assets of a company.
Types of a Liability
1. Current Liabilities – Also known as short-term liabilities they are payable within 12 months or within the operating cycle of a business. Examples – trade creditors, Bills payable, outstanding expenses, bank overdraft etc.
2. Non-current Liabilities – Also termed as fixed liabilities they are long-term obligations and the business is not liable to pay these within 12 months. Examples – long-term loans, bonds payable, debentures, etc.
3. Contingent liabilities – are liabilities that may come into existence depending on the outcome of a future occurrence. In case the event does not happen, an organization is not liable to pay anything. They are shown as a footnote to the balance sheet. Examples of contingent liabilities are
Product warranty claims
Guarantee for loans
4. Owner’s funds/Capital/Equity – Last among types of liabilities is the amount owed to proprietors as capital, it is also called owner’s equity or equity.
Internal and External Liabilities
Internal – It is payable to internal parties such as promoters (owners), employees etc. Example – Capital, Salaries, Accumulated profits, etc.
External – It is payable to external parties such as lenders, vendors, etc. Example – Borrowings, Creditors, Taxes, Overdraft, etc.
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