Liability
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In accounting
In accounting, a financial liability is something that is owed to another party. This is typically contrasted with an asset which is something of value that is owned. The basic accounting equation relates assets, liability, and capital in the form of equity:
- liabilities + equity = assets,
Where assets are that which is owned, liabilities are that which is owed to others, and equity is that which has been invested in the venture.
Probably the most accepted accounting definition of liability is the one used by the International Accounting Standards Board (IASB). The following is a quotation from IFRS Framework:
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. [F.49(b)]
Regulations as to the recognition of liabilities are different all over the world, but are roughly similar to those of the IASB. Examples of types of liabilities include: money owing on a loan, money owing on a mortgage, or an IOU.
Classification of liabilities
Liabilities are reported on a balance sheet and are usually divided into two categories:
- Current liabilities — these liabilities are reasonably expected to be liquidated within a year. They usually include payables such as wages, accounts, tax]s, and accounts payables, unearned revenue when adjusting entries, portions of long-term bonds to be paid this year, short-term obligations (e.g. from purchase of equipment), and others.
- Long-term liabilities — these liabilities are reasonably expected not to be liquidated within a year. They usually include issued long-term bonds, notes payables, long-term leases, pension obligations, and long-term product warranties.
An example
Money that is accumulated is an asset. It is something of value that is owned. If money is taken to a bank and deposited there, it becomes a liability of the bank, who owes the depositor the money. The money is both an asset to the individual and a liability of the bank.
Assets increase when debited while liabilities increase when credited. A deposit to the bank is treated as a "credit" because the bank's liability its customers the depositor increases. The money itself remains an asset or a debit to the depositor. This confusion of whose debits and credits one is talking about is a source of much misunderstanding for newcomers to accounting.
