What Is an Example of a Liability in Accounting?

An accounting liability represents a financial obligation that a business owes to another party. These obligations arise from past transactions or events and require a future outflow of economic benefits, such as cash, goods, or services, to settle them. Understanding liabilities is fundamental to assessing a company’s financial position, as they signify claims against its assets.

Defining a Liability

From an accounting perspective, a liability has three distinct characteristics. It must be a present obligation, meaning a current duty or responsibility to another entity. This obligation arises from past transactions or events. Finally, its settlement is expected to result in an outflow of economic benefits, such as cash, assets, or services. The Financial Accounting Standards Board (FASB) defines liabilities as “probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.”

Categorizing Liabilities

Liabilities are primarily categorized based on the timing of their expected settlement. This classification distinguishes between current liabilities and non-current liabilities. Current liabilities are obligations that a company expects to settle within one year or within its normal operating cycle, whichever is longer. Non-current liabilities, conversely, are obligations that are not expected to be settled within this one-year or operating cycle timeframe. This distinction is important for financial statement users to understand a company’s short-term liquidity and long-term solvency.

Common Current Liabilities

Several common obligations fall under the current liabilities category, reflecting short-term financial commitments. Accounts Payable represents amounts a company owes to its suppliers for goods or services purchased on credit, typically due within a short period. Salaries Payable includes compensation owed to employees for work already performed but not yet paid, arising because companies often pay employees after the work period has ended.

Short-Term Loans are also current liabilities, encompassing amounts borrowed from banks or other lenders that must be repaid within one year. These loans often cover immediate operational needs or temporary cash flow shortages. Unearned Revenue, also known as deferred revenue, occurs when a company receives cash for goods or services before they have been delivered. For instance, if a customer pays for a one-year subscription upfront, the company records it as unearned revenue until the service is provided. As service is delivered, the liability decreases, and revenue is recognized.

Common Non-Current Liabilities

Non-current liabilities represent obligations that extend beyond one year, providing insight into a company’s long-term financial structure. Long-Term Loans are a primary example, referring to debt obligations from banks or other financial institutions that mature in more than twelve months. These loans often finance significant investments. The principal portion of these loans due within the next year is reclassified as a current liability, but the remainder stays non-current.

Bonds Payable are another significant non-current liability. These are formal debt instruments issued by companies to borrow large sums of money directly from investors. The company promises to make periodic interest payments and repay the principal amount on a specified future maturity date. Deferred Tax Liabilities also fall into this category, arising from temporary differences between a company’s accounting profit and its taxable income. For example, if a company uses accelerated depreciation for tax purposes, it may pay less tax currently but will owe more tax in future periods, creating a deferred tax liability.

Liabilities and Financial Statements

Liabilities are presented on a company’s balance sheet, which provides a snapshot of its financial position at a specific point in time. On the balance sheet, liabilities are typically listed on the right side, along with owner’s equity, balancing against the assets on the left side. They are generally organized in order of liquidity, with current liabilities presented before non-current liabilities. This arrangement allows stakeholders to quickly assess which obligations are due in the near term versus those with longer repayment horizons. The balance sheet’s presentation of liabilities, alongside assets and equity, offers a comprehensive view of a company’s financial health and its ability to meet its obligations.