In the most general sense, a liability is anything that is a hindrance, or puts individuals at a disadvantage.
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:
Where assets are what is owned, liabilities are what is owed to others, and equity is what is have contributed to the venture.
In technical terms, the Australian Accounting Research Foundation [1] defines liabilities as future sacrifice of economic benefits that the entity is presently obliged to make to other entities as a result of past transactions and other past events. Regulations as to the recognition of liabilities are different all over the world, but are roughly similar to those of the International Accounting Standards Board (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, taxes, 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.
In law
- In commercial law, limited liability is a form of business ownership in which business owners are legally responsible for no more than the amount that they have contributed to a venture. If for example, a business goes bankrupt an owner with limited liability will not lose unrelated assets such as a personal residence (assuming they do not give personal guarantees). This is the standard model for larger businesses, in which a shareholder will only lose the amount invested (in the form of stock value decreasing). For an explanation see business entity.
- Manufacturer's liability is a legal concept in most countries that reflects the fact that producers have a responsibility not to sell a defective product. See product liability.
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.
See also
