What Is Considered a Liability on a Balance Sheet?

A balance sheet provides a financial snapshot of a company at a specific moment in time. It is one of three foundational financial reports, alongside the income statement and cash flow statement, used to evaluate a business’s performance. It presents what a company owns, what it owes, and the amount invested by its owners. The balance sheet categorizes items into assets (economic resources controlled by the company), liabilities (obligations to external parties), and equity (owners’ residual claim on assets).

Characteristics of Liabilities

A liability represents an obligation a business has to an outside party. These obligations arise from past transactions or events, creating a present duty for the company. Settlement of a liability typically involves an outflow of economic benefits, such as cash, other assets, or services.

For an item to be considered a liability, it must meet several criteria. First, there must be a present obligation to another entity. Second, this obligation must stem from an event or transaction that has already occurred. Third, the company must have little to no discretion to avoid settling this obligation. Finally, the settlement of this duty will require the company to give up resources that embody economic benefits.

Classification of Liabilities

Liabilities are categorized on a balance sheet based on their due date, distinguishing between current and non-current obligations. This classification provides insights into a company’s short-term and long-term financial commitments. Current liabilities are financial obligations a company expects to settle within one year from the balance sheet date or within its normal operating cycle, whichever is longer.

Non-current liabilities, also known as long-term liabilities, represent obligations not due for settlement within one year or one operating cycle. This distinction helps stakeholders assess a company’s liquidity and solvency, ensuring financial statements accurately reflect its ability to meet immediate and future financial demands.

Common Examples of Liabilities

Current liabilities encompass various short-term financial obligations that businesses regularly encounter. Accounts payable, for instance, are amounts owed to suppliers for goods or services purchased on credit during normal operations. Short-term notes payable represent formal written promises to pay a specific sum, often with interest, within one year, typically used for immediate cash needs or inventory purchases.

Unearned revenue (deferred revenue) is money received from customers for products or services not yet delivered or performed, creating an obligation to provide them. Accrued expenses are costs that a company has incurred but has not yet paid, such as salaries, utilities, or interest, and are recognized when incurred rather than when cash is paid.

Non-current liabilities include obligations that extend beyond one year. Long-term debt, such as bank loans or bonds payable, represents significant borrowings used to finance operations or large expansions, with repayment terms extending over several years.

Deferred tax liabilities arise when a company records taxes that are owed but are not due to be paid until a future date, often due to temporary differences between accounting rules for financial reporting and tax regulations. For example, using accelerated depreciation for tax purposes while using straight-line depreciation for financial statements can create such a difference, leading to a deferred tax liability.

Liabilities and the Accounting Equation

Liabilities play a fundamental role in the accounting equation: Assets = Liabilities + Equity. This equation illustrates that a company’s assets are financed either by what it owes to external parties (liabilities) or by what its owners have invested (equity).

Liabilities represent external claims against a company’s assets, such as obligations to creditors and suppliers. In contrast, equity signifies the internal claims of owners on the company’s assets after all liabilities have been satisfied. The balance sheet remains in balance because every financial transaction affects at least two accounts, ensuring that total assets always equal the sum of liabilities and equity.