In the most general sense, a liability
is anything that is a hindrance
, or puts individuals at a disadvantage.
In financial accounting
, a liability
is defined as an obligation
of an entity arising from past
transactions or events, the settlement of which may result in the transfer or use of assets
, provision of services or other yielding of economic benefits in the future. Individual or group must adopt corporate charter and file it with the state.
- They embody a duty or responsibility to others that entails settlement by future transfer or use of assets, provision of services or other yielding of economic benefits, at a specified or determinable date, on occurrence of a specified event, or on demand;
- The duty or responsibility obligates the entity leaving it little or no discretion to avoid it; and,
- The transaction or event obligating the entity has already occurred.
Liabilities in financial accounting need not be legally enforceable; but can be based on equitable obligations or constructive obligations. An equitable obligation is a duty based on ethical or moral considerations. A constructive obligation is an obligation that can be inferred from a set of facts in a particular situation as opposed to a contractually based obligation.
The accounting equation relates assets, liabilities, and owner's equity:
- Assets = Liabilities + Owner's Equity
The accounting equation is the mathematical structure of the balance sheet
The Australian Accounting Research Foundation defines liabilities as future sacrifice of economic benefits that the entity is presently obliged to make to other entities as a result of past transactions and other past events.
Probably the most accepted accounting definition of liability is the one used by the International Accounting Standards Board (IASB). The following is a quotation from IFRS Framework:
Regulations as to the recognition of liabilities are different all over the world, but are roughly similar to those of the IASB.
Examples of types of liabilities include: money owing on a loan, money owing on a mortgage, or an IOU.
Classification of accounting liabilities
are reported on a balance sheet
and are usually divided into two categories:
- Current liabilities — these liabilities are reasonably expected to be liquidated within a year. They usually include payables such as wages, accounts, taxes, and accounts payables, unearned revenue when adjusting entries, portions of long-term bonds to be paid this year, short-term obligations (e.g. from purchase of equipment), and others.
- Long-term liabilities — these liabilities are reasonably expected not to be liquidated within a year. They usually include issued long-term bonds, notes payables, long-term leases, pension obligations, and long-term product warranties.
Liabilities of uncertain value or timing are called provisions - see Provision (Accounting).
Bank account example
Money deposited with a bank becomes a liability of the bank, because the bank has an obligation to pay the depositor the money deposited; usually on demand. (The money deposited is an asset
for the depositor; but this asset will not be recorded by the bank because it is not the bank's asset. If the depositor maintains accounting records separate and apart from the bank account maintained by the bank, only then will the asset be recorded.)
A debit increases an asset; and a credit decreases an asset. A debit decreases a liability; and credit increases a liability.
When a bank receives a deposit it credits a liability account called "Deposits" and credits the depositor's bank account for the same amount (the bank's "Deposits" account is the sum of all of the amounts credited to all of its customer's individual bank accounts). A deposit received by a bank is credited because the bank's liability to its customer, the depositor, increases. When a bank informs its depositor that it has debited the depositor's bank account, it means that the depositor's bank account has been decreased by the amount debited.
- In law a legal liability is a situation in which a person is financially and legally responsible, such in situations of tort concerning property or reputation and, therefore, must pay compensation for any damage incurred; liability may be civil or criminal. See Strict liability. Under English law, with the passing of the Theft Act 1978, it is an offense to dishonestly evade a liability. Payment of damages usually resolved the liability. Vicarious liability arises under the common law doctrine of agency – respondeat superior – the responsibility of the superior for the acts of their subordinate.
- In commercial law, limited liability is a form of business ownership in which business owners are legally responsible fo no more than the amount that they have contributed to a venture. If for example, a business goes bankrupt an owner with limited liability will not lose unrelated assets such as a personal residence (assuming they do not give personal guarantees). This is the standard model for larger businesses, in which a shareholder will only lose the amount invested (in the form of stock value decreasing). For an explanation see business entity.
- Manufacturer's liability is a legal concept in most countries that reflects the fact that producers have a responsibility not to sell a defective product. See product liability.