Liabilities and Their Classification [Notes with PDF]
In this article, we will learn in-depth about liabilities and their classification and much more.
What is the Liability?
The sacrifice against the acquisition of property and services is usually a liability.
The amount that has not yet been paid will have to be paid in the future against the acquisition of property and services from another person or institution is called a liability.
The amount payable will be the liability of the businessman or business entity.
Any legitimate claim against a business’s property is called a liability. Liability generally refers to the outside.
Examples of Liabilities are Capital, Provident fund, Accounts payable, Notes Payable, Bank overdraft, Bank Loan, Expenses Payable, etc.
Classification of Liabilities
The different types of liabilities are as follows
1. Internal Liabilities
The liability of the owner or owner of the organization or the liability of the company to the shareholders is referred to as internal liability.
Internal liability is the sum of the debts of the owner of the business. Accepted by the owners or shareholders, on payment or refund.
This type of liability is usually the result of the concept of a business entity.
Examples of Internal Liabilities:
- Capital
- Share Capital
- Reserve Fund
- Share Premium
- Pension Fund
- Bonus Fund
- Welfare fund
- Retained Earnings
2. External Liabilities
The aggregate of the debts owed by the organization to any party other than the owner of the business is referred to as external liability.
The sum of current liabilities and long-term liabilities is referred to as external liabilities.
Examples of External liabilities:
- Accounts Payable
- Bank Loan
- Bank Overdraft
- Liability for Guarantee
2.1. Current Liability
A liability that is limited to a short term, two or three months, a maximum of one year and a fixed period is referred to as the current liability.
Current liabilities or short-term liabilities are all liabilities that need to be repaid in an account or in a short period of time.
Examples of Current Liabilities:
- Accounts Payable
- Notes Payable
- Unearned Revenue
- Bank Overdraft
- Expenses Payable
- Short Term Loan
2.2. Long-term Liability
Long-term liabilities are generally referred to as long-term liabilities created for two or three years or more.
Liabilities that generally do not require payment within one year or are accepted for multiple accounting periods are defined as permanent or long-term liabilities.
These liabilities are commonly used for capital expenditure.
Examples of Long Term Liabilities
- Bank Loan
- Mortgage Loan
- Debenture
- Other Long-term Liabilities
2.3. Contingent Liability
A contingent or uncertain liability is one that is subject to an event, that is, an event that may or may not be regarded as a liability to a business.
Contingent liabilities are claims that may be considered future business liabilities.
According to the principle of conservatism, a contingent liability is considered a liability.
According to the principles of full disclosure, a contingent liability is to be shown as a footnote in the Balance sheet.
Examples of Contingent Liabilities:
- Liability for Guarantee
- Liability for awaiting the court’s Judgment
- Liability for Discounting Bills/Notes
I think you’re clear about the liabilities and their classification after reading this article.
You can also read:
- Assets and Their Classification
- Everything about Income Statement
- Everything about Financial Statement
Key takeaways
- A liability is an amount the business owes to others as a result of past transactions, settled with cash, goods or services.
- Current liabilities are due within a year or the operating cycle. Non-current liabilities are due later.
- Liabilities normally have a credit balance.
- The part of a long-term loan due within a year is shown as a current liability.
Quick check
1. Classify each: bank overdraft, a 5-year bank loan, accrued wages, accounts payable.
Bank overdraft: current. 5-year loan: non-current (apart from the part due within a year). Accrued wages: current. Accounts payable: current.
2. A 100,000 loan is repaid in equal yearly amounts over 5 years. How is it shown at the start of year 1?
20,000 as a current liability (due this year) and 80,000 as non-current.
Frequently asked questions
What is the difference between current and non-current liabilities?
Current liabilities must be settled within one year or the operating cycle. Non-current liabilities are due after more than one year.
What is the difference between a liability and an expense?
A liability is an amount owed at a point in time and appears on the balance sheet. An expense is a cost for a period and appears on the income statement. An unpaid expense creates a liability.
What is a contingent liability?
A possible obligation that depends on an uncertain future event, such as a lawsuit. It is usually disclosed in the notes. If payment is probable and can be measured reliably, a provision is recorded instead.
Related: Liability (glossary) · Accounts payable · Accrued expense
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