Obligation definition
/What is an Obligation?
An obligation is a commitment to pay a third party based on an underlying contract, such as a purchase order, mortgage, or bond issuance.
Characteristics of an Obligation
The characteristics of an obligation in a business setting typically include the following:
Legally binding. Obligations are enforceable by law and often arise from contracts, agreements, or regulations.
Defined terms and conditions. Obligations include specific expectations, timelines, deliverables, or requirements the business must meet.
Financial impact. Obligations often involve monetary transactions, such as debt repayment, taxes, or compensation.
Accountability. A business is responsible for fulfilling the obligation and can face penalties, lawsuits, or loss of reputation if it fails to meet them.
Specificity. An obligation has a clearly defined scope, such as a deliverable product, service, payment, or compliance with a regulation.
Time-bound. Many obligations have deadlines or fixed durations by which they must be fulfilled.
Accounting for an Obligation
If the obligation is probable and the amount can be determined, then it is recorded in an entity's accounting records as a liability. The journal entry used to record this obligation includes a credit for the obligation, while the offsetting debit may be to an expense or asset account. For example, if you incur a $10,000 obligation to pay for a new machine, then the debit would be to the Machinery fixed assets account.
Presentation of an Obligation
If an obligation is due within one year, it is classified as a current liability. If the obligation is due over a longer period, it is classified as a long-term liability. Obligations are typically recorded within a few standard liability accounts, such as trade payables, payroll taxes payable, accrued liabilities, and long-term debt.