Definition of Types of Liabilities on Balance Sheet
A Balance Sheet represents the financial position of a company at a given point of time. It comprises of the company’s assets, liabilities and stockholder’s equity. As per the International Accounting Standards Board (IASB), a liability is defined as“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.”
Explanation
Liabilities are obligations of the company that arise as a result of past transactions. Hence, they usually have the word ‘payable’ in them. Liabilities also arise if an amount is received for goods/services that are yet to be provided. In such cases, the companies ‘defer’ reporting of revenue and recognizes the amounts earned as a liability by the name ‘Unearned revenue’.
There are mainly three types of liabilities on a Company’s Balance Sheet:
- Non-Current Liabilities: Non-current liabilities are long-term liabilities. These are payable after a period of 12 months or more from the date of the Balance Sheet.
- Current Liabilities: Current Liabilities are payable within 12 months (or the company’s operating cycle)from the date of the Balance Sheet.
- Contingent Liabilities: Contingent liabilities are those liabilities for which the company is still not legally responsible. They can become liabilities in the future and are also called ‘potential liabilities. If the probability of occurrence is less than 50%, they are depicted as footnotes in the Balance-sheet. If the probability of occurrence is high and can be estimated, they are shown as liabilities in the Balance Sheet and the estimated loss is recorded in the income statement.
For example, if the company has been sued for $10,000 and there is a 70% probability that the company will lose the case and pay the damage amount, it should be recorded in the Balance Sheet as a liability.
Asset accounts usually have debit balances while liability accounts have credit balances. However, certain accounts known as ‘contra-liabilities’ accounts have debit balances. This explains the usage of the term ‘contra’ since their debit balance is ‘contrary’ to the usual credit balances of liability accounts. Examples include accounts such as discount on bonds payable, discount on notes payable etc.
For example, if a company issues bonds for $10,000 at a discount of 10%, it would record the following:
- $9000 would be the debited to the cash account
- $10,000 would be credited to the Bonds Payable account
- $1000 would be debited to the ‘Discount on Bonds payable’ known as contra-liability and used to adjust the book value of the liability (Bonds Payable in this case).
Commitments that a company has (such as a contract that would become effective in case of a future event like purchase/sale of goods and services) are not considered liabilities. However, they should be disclosed in the notes to the Balance Sheet if the amount of ‘commitment’ is a significant amount.
The below is a brief explanation of the most common liabilities that are found on a Company’s Balance Sheet.
Types of Current Liabilities
- Accounts Payable: These are also known as Trade Creditors. They are payable to the suppliers of goods/services for the services utilized by the company.
- Income taxes payable: This represents the taxes such as Income Tax, Sales Tax, etc. that are be payable by the firm.
- Interest Payable: This represents the interest on loans taken, bonds issued, etc. which is payable by the firm. The interest on the loan that related to the future is not recorded on the balance sheet. It is only the unpaid interest up to the date of the balance sheet that is reported as a liability.
- Accrued Expenses: In accrual system of accounting, expenses are recognized when they are incurred whether or not payment has been made. Accrued expenses represent such expenses that have incurred and been recorded in the balance sheet but are yet to be Examples include salaries for the previous month that are payable in the next month.
- Unearned Revenue: This represents advances received from customers on account of sale of goods/services. Since the goods/services have not been provided yet by the firm, this is termed as ‘unearned revenue’.
- Mortgage Payable: This is the mortgage amount payable on the purchase of a long-term property. If the conditions of the mortgage payable include making monthly payments for a period of several years, only the principal due in the next twelve months is recorded as a current liability. The outstanding principal amount is recorded as a long-term liability.
Below is a brief description of Non-current liabilities found on a Company’s Balance Sheet:
- Bonds Payable: Bonds are financial instruments that represent the Corporate debt taken over by the company. These are usually redeemable after a definite period of time(usually a few years). The company borrows funds by issuing bonds, provides interest on such bonds at a fixed tenure, and redeems the bond to return back the borrowed funds. Such liability is thus a long-term liability.
- Long-Term Notes Payable: Notes are legal instruments in which one party pay a specific amount of money either on-demand or at a pre-determined time.
- Deferred Tax Liabilities: These are liabilities that arise due to the difference in accounting income and taxable income of a company. When such a difference results in taxes accrual in the current period but payable later, it is a deferred tax liability.
- Capital Leases: These are also known as a finance lease. The present obligation under a Capital lease arrangement is debited to the fixed asset account and credited to the capital lease account.
Below are examples of contingent liabilities:
- Pending Lawsuits: Lawsuits where the company thinks that the suing firm has a strong case should be recorded in the Balance sheet.
- Product warranties: These are compensation guarantees provided on the quality of the product. Since the outcome is uncertain, these are usually mentioned in the foot-notes of the Balance Sheet.
Conclusion – Types of Liabilities on Balance Sheet
The liabilities on the Balance Sheet of a company are used to expand the firm and finance its operations. The management and analysts observe short-term liabilities closely since they are indicators of the firm’s short-term liquidity and its ability to pay for its obligations.The long-term liabilities are a source of the company’s long-term financing needs such as purchase of assets or investments in capital-intensive projects.
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