The term liability is widely used in economics and finances. It’s exact definition depends on the application of the word.
What Is a Liability?
In the world of financial accounting, a liability is defined as an obligation or debt that a business acquirees during operations. These financial obligations must be settled by the business – whether it be through money, goods or services. Common liabilities include accounts and taxes payable, business loans and property mortgages.
Liabilities on a Balance Sheet
A balance sheet lists the financial summary of a business organization. The standard balance sheet is composed of two parts: assets and liabilities.
Assets are entities the company owns. This includes physical items (equipment, owned real estate, inventory) and intangible properties (intellectual property, patents, brand rights.)
Liabilities are debts owed on the company. When a business lists a liability on their balance sheet, they are reporting an overdue debt.
These liabilities are divided into two categories: current and long-term.
Current Liability and Long-Term Liability
The difference between current and long term liability is the time a business has to settle the debt.
– Accounts Payable. Bills owed to suppliers and vendors.
– Taxes Payable. Sales, income, and payroll taxes that need to be paid.
– Short-term Bank Loans and Promissory Notes. Any loans or borrowed money that is payable within one year or less.
– Interests Payable. Interest due on a loan (not to be confused with dividends owed to shareholders.)
– Accrued Expenses. Invoices that have not yet come due, but will need to be settled in the near future – such as wages payable.
A long-term liability is paid over a longer period. This can include a mortgage payable over the course of several years or a multi-year lease on a property. Long-term liabilities can also include long-term loans, pension and healthcare obligations, and deferred taxes and liabilities.
The Difference Between Liabilities & Expenses
In order to determine net profit, a company takes their revenue and subtracts expenses. While liabilities are listed on a company’s balance sheet, expenses are a part of their income statement.