Liabilities are legally binding obligations that are payable to another person or entity. Settlement of a liability can be accomplished through the transfer of money, goods, or services. A liability is increased in the accounting records with a credit and decreased with a debit.
A liability can be considered a source of funds, since an amount owed to a third party is essentially borrowed cash that can then be used to support the asset base of a business.
Examples of liabilities are:
- Accounts payable
- Accrued liabilities
- Deferred revenue
- Interest payable
- Notes payable
- Taxes payable
- Wages payable
Liabilities are aggregated on the balance sheet within two general classifications, which are current liabilities and long-term liabilities. You would classify a liability as a current liability if you expect to liquidate the obligation within one year. All other liabilities are classified as long-term liabilities. If you have a long-term note or bond payable, that portion of it due for payment within the next year is classified as a current liability. Most types of liabilities are classified as current liabilities, including accounts payable, accrued liabilities, and wages payable.
It is possible to have a negative liability, which arises when a company pays more than the amount of a liability, thereby theoretically creating an asset in the amount of the overpayment. Negative liabilities tend to be quite small.
A contingent liability is a potential liability that will only be confirmed as a liability when an uncertain event has been resolved at some point in the future. You should only record a contingent liability if it is probable that the liability will occur, and if you can reasonably estimate its amount. The outcome of a lawsuit is a typical contingent liability.
A provision is a liability or reduction in the value of an asset that an entity elects to recognize now, before it has exact information about the amount involved. For example, an entity routinely records provisions for bad debts, sales allowances, and inventory obsolescence. Less common provisions are for severance payments, asset impairments, and reorganization costs.