What is a liability?
In business, a liability is something that a company owes. This can mean debt or another type of obligation such as taxes or outstanding wages. It can also cover money paid to the company for work which has not yet been carried out. This is known as deferred revenue, as the company cannot count it until they have done the work.
Liabilities are settled through the transfer of money, services or goods. Liabilities can include loans, mortgages, accounts payable, accrued expenses and earned premiums.
A liability is an obligation between two parties for something that is not yet completed or paid for. A financial liability also presupposes previous business transactions, sales, events, exchange of services or assets that is expected to provide economic benefit later.
What you need to know about liabilities
Liabilities are used by investors to estimate and compare companies’ performance. This is not always straightforward as the way liabilities are recorded can vary.
There are two major types of liability – current liabilities and long-term liabilities.
- Current liabilities are debts that need to be paid within a year – wages, for example.
- Long-term liabilities are payable over more than one year. For example, if a company takes a mortgage payable within a 20-year period.
A liability has several major characteristics:
- A type of borrowing from a bank or person to improve a business or personal income, which is payable at a predefined short or long period.
- A responsibility to other parties that presupposes settlement by transfer or use of assets in future, provision of services or other transaction(s) at a specified date or on demand.
- A duty that obligates one entity to another with no discretion to avoid settlement
- An event or a transaction, obligating the entity that has already occurred.
The relationship between liabilities and assets
Assets are things a company owns. These include tangible items, such as equipment, machinery, buildings, and intangible items, such as interest owed, accounts receivable, intellectual property and patents.
If we subtract the company’s liabilities from its assets, we will get the owners’ or shareholders’ equity:
Assets – Liabilities = Shareholders’ Equity
Generally, this fundamental accounting equation is presented as follows:
Liabilities + Shareholders’ Equity = Assets
Liability vs expense
Simply put, liabilities are the obligations and debts that a company owes, while expenses are the costs of a company’s operation. Whereas liabilities are listed on a company’s balance sheet, expenses are listed on an income statement.