What is a Liability?
In accounting and finance, a liability is a legal debt or obligation that an entity (such as a business or organization) is required to pay back.
The International Accounting Standards Board’s (IASB’s) definition of a liability is currently the most widely accepted. It states:
“A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”
Liabilities are reported on the right side of a balance sheet. Examples of liabilities include loans, accounts payable, accrued expenses, bonds payable, interest payable, wages payable, and income taxes payable.
Liabilities are an important element of the operations of a company. They are key in helping financial operations and achieving growth. In addition, liabilities facilitate and more efficiently allow transactions between businesses.
Liabilities form part of the accounting equation:
Assets = Liabilities + Stockholders’ Equity
When a company’s total liabilities exceed its total assets it is insolvent. A solvent company is one whose total assets exceed its liabilities.
The characteristics of a liability:
- A long or short-term loan provided by a bank so that a business has the necessary funds to complete a project.
- A duty for an entity to provide a future transfer of assets or services at a specified date (or on demand) to another party.
- A claim on the assets of a company.
Types of liabilities:
On a balance sheet liabilities are typically divided into two groups; current liabilities and long-term liabilities.
Current liabilities – these are debts or obligations that are due within 12 months (within the fiscal year or the operating cycle of a business). Examples of current liabilities include interest payable, dividends payable, rental payments, and accounts payable.
Long-term liabilities – these are debts or obligations that are not liquidated within 12 months, such as long-term leases, long-term bonds, and pension obligations.
Liabilities without a specified time due or unknown value are known as provisions.
Liabilities in banking
In banking, the money that is deposited is considered to be a liability as the bank has an obligation to pay the person who deposited the money (for the amount they deposited plus interest).
A pension liability is the difference between how much money is due to retirees and the actual amount the company has on hand to meet those payments.
In non-accounting and non-finance contexts, liability can mean:
A hindrance or handicap, as in “After the scandal the party leader became a liability regarding the forthcoming elections.”
Responsibility, as in “He denies liability for the plane crash.”
Video – What is a liability?