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written by | April 25, 2022

Accounting Liabilities: What Are They?

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Liabilities in accounting are always on the right-hand side of a balance sheet. The different types of liabilities can be loans taken by businesses from banks or other financial entities and their failure to repay on time. Liabilities also include delayed payments of taxes, wages and mortgage debt. In the case of individuals, liabilities include delay in payment of loans obtained from banks, delay in paying taxes, or a host of other unpaid bills. You can settle liabilities in different ways. Some of these include the transfer of money and products.

Any liabilities that extend upto 12 months or less than 12 months are current or short-term liabilities. Liabilities that stretch beyond 12 months are non-current liabilities or long-term liabilities. A liability can be real or potential. A real liability, e.g. is a property bill that you have to pay. Potential liability can be the possibility of a lawsuit slapped on you by someone for a specific reason. All liabilities are legally binding upon the borrowers.

Did you know?

In 2019, Vodafone Idea reported a corporate liability of ₹50,922 crores for a specific financial quarter?

What Are Liabilities in Accounting?

The total liabilities of any organisation are the aggregate of its short-term and long-term liabilities. The simple formula to understand liabilities is as follows:

Assets: Total value of the entire premises that an organisation owns.

Equity: The stake the Founder or Founders hold in the organisation.

Liabilities – The financial obligations of the said business.

Thus, liabilities are the difference between the assets minus the equity. Liabilities in accounting include the financial obligations of a business. The obligation could be:

  • A current one – is some recent unpaid taxes.
  • An obligation that has occurred in the past – bank loans or mortgages.
  • Settlement of the same.

Liabilities in accounting include:

  • Current
  • Non-current or long-term
  • Contingent

Also Read: Know about Balance Sheet - Definition & Examples

Current Liabilities

As the name suggests, current liabilities are financial obligations that an organisation owes in the current financial year. An organisation needs to fulfil these types of liabilities before completing one year. For this reason, they are short-term liabilities. Typical examples of current liabilities are bank overdrafts, short-term loans taken by an organisation, accounts payable, dividends that need to be payable and expenditures that have accumulated and interest that we need to pay on something specific.

Non-Current or Long-term Liabilities

These are financial obligations that expect an organisation to pay beyond the timeframe of a year. When an organisation discovers it cannot settle its long-term dues, it indicates it is in a crisis. Long-term liabilities include notes payable, delayed tax settlements, bonds payable, rent obligations (lease agreement) and deferred payment towards machinery and other equipment.

Contingent Liabilities

These types of liabilities are self-explanatory. These arise based on some unforeseen events in the future. This could be high volatility in the global economy, which could be due to bad weather conditions like floods or drought, war-like situations, pandemics or even competition in the market space. These are based on conjecture. Some examples of contingent liabilities include lawsuits or even a product warranty.

How to Find Liabilities?

Liabilities play a vital role in the operations of any business. They give an instant understanding of the total amount of debt that a company has to settle within a year or in the future. This clarity provides a business with a better understanding of whether it should procure more loans or decide on a strategy that will boost profits. There are different ways to assess liabilities and decide on a course of action based on those details. Some of these are below:

The Importance of Organising the Liabilities

As a business house, you should collate all accounts information. This will showcase the liabilities you owe to others. Once you have the details, categorise the liabilities e.g.

Rent - ₹ 25,000  

Loans taken for business - ₹800,000

Taxes to be paid - ₹1,35,000

Accounts payable - ₹85,000

You can resort to some of the professional accounting softwares, which are formulated with all the various categories. This softwares facilitate the detailing in an organised manner.

Short-term and long-term Categorisation

This categorisation will give you an insight into liabilities you have to fulfil soon and help you understand the long-term ones. These details will help you strategise your business plans for the future accordingly.

Resort to a Professional Software for Efficient Computation

You can use specific software to sum up the total assets and liabilities. Professional software eases the computations and speeds the computing processes. You will be able to get accurate numbers of your current, non-current, and contingent liabilities.

Examples of Liabilities

Current Liabilities

Short-term Loans

Trade credit, credit cards, bank overdrafts.

Bank Overdrafts

When you write a cheque for an amount that exceeds the revenue amount in your bank account, e.g. your business account has a balance of ₹20,000, and you issue a cheque of ₹40,000. If the bank clears your cheque, your business account has been overdrawn by ₹20,000.

Accounts Payable

Procurement of raw materials, lease payments, licence payments, and logistics.

Interest Payable

You take a loan of ₹1,000,000 to pay at an interest rate of 6% to the financial lenders at the end of every quarter. You will have to pay ₹ 5,000 at the end of each month. This becomes the debit to the account of interest expenditure and a credit to the interest payable account.

Notes Payable

This includes the purchase of an asset like premises, a vehicle or even a bank loan.

Revenue Unearned

This includes payment of rent in advance, tickets for air travel, prepaid amount towards insurance or making a payment towards an annual subscription use of the software.

Accrued Expenses

This includes expenditures for which the bank hasn’t procured any documentation.

Lease Payable

This includes payments made based on a lease agreement, e.g. purchase of land, a vehicle, software or even distinct equipment for a computer.

Non-current Liabilities

Long-term Loans

This includes loans taken towards payment of loans towards purchasing a house, car, loans for a small scale business and personal loans.

Debentures

This includes treasury bills and bonds.

Bonds Payable

This includes financing of projects and new infrastructure, among many others.

Delayed tax Liabilities

This includes taxes that a business owes, but the company has to make the payment at a specific time in the future.

Contingent Liabilities (some are self-explanatory)

A Lawsuit

This includes expenses connected with the repairs of defective goods or the replacement of such goods. Suppose a client files a lawsuit of ₹100 for receiving a damaged product. The legal division of the business believes that the client has concrete proof of the same. There are chances that the company may incur a liability of ₹100, and therefore it makes an entry in its financial statement. The business will record a debit in legal expenses and credit in the account of accrued costs.

Potential Lawsuits

This can include lawsuits for patent theft.

Product Warranties

Let’s assume a business sells two-wheelers. It is supplying three years of proof on the engine of the same. Each engine costs ₹1,000. If the company sells about 5000 two-wheelers, it will have to estimate how many of them could come to replace the engine during the warrantied timeframe. The business will make a provision of contingent liability in its financial statement. Let’s assume that the business considers about 25% of the two-wheelers requesting an engine replacement. This would amount to 1,250 two-wheelers multiplied by the cost of each engine, i.e. ₹1,000. The contingent liability would amount to ₹1,250,000.

Changes in the Policies of the Government

If a business house believes that the chances of a change in the government policies are high, this will increase the prices of its goods.

Also Read: Accounting Equation: Overview, Formula, and Examples

Bank Guarantees

If ABC takes a loan of ₹1,000 and XYZ offers a guarantee on that loan. If ABC cannot make the said payment, then XYZ will be accountable for the same to the said bank, and this will reflect as a contingent liability in the books of accounts of XYZ.

Changes in Foreign Exchange

This includes the impact on transactions that take place in foreign currencies.

Liquidated Damages

When there is a mutual agreement of payment from one to another business entity and defaults, the non-defaulting entity can file a case to procure a judgement for the liquidated damages. The defaulter makes an entry of a contingent liability in its financial statement.

Conclusion

The details of this article helps understand the various types of liabilities in accounting. Every business must understand its immediate or current liabilities and its long-term or non-current liabilities. This aids a business to know how to plan for expansion and making appropriate choices for availing of more loans or continuing with the current level of liabilities. 

Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.

FAQs

Q: What are some of the examples of assets and liabilities?

Ans:

  • Assets include cash reserves, investments, commercial premises, accounts receivable and goodwill.
  • Liabilities include interest payable, accounts payable, accrued expenses and bank overdrafts, among many others.

Q: Define liabilities in accounting?

Ans:

Liabilities in accounting always reflect on the right-hand side of a balance sheet. These include current liabilities (payable within 12 months) and non-current liabilities (payable beyond the timeframe of 1 year). Contingent liabilities are potential liabilities based on various factors.

Q: What are the various types of liabilities in accounting?

Ans:

The various types of liabilities include current, non-current contingent and capital.

Q: What is liability meaning in accounts?

Ans:

All liabilities are invariably settled either via cash, products or the transfer of various economic benefits, and this is done over a specific timeframe.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.