Liability

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What is a 'Liability'

Liability is a company's legal debt or obligation that arises during the course of business operations. Liabilities are settled over time through the transfer of money, goods or services. Recorded on the right side of a balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues and accrued expenses. Liabilities are a vital aspect of a company's operations because they are used to finance operations and pay for expansions.

BREAKING DOWN 'Liability'

Liability represents a firm's unconditional promise to transfer resources to another party as of the date of the financial statements. Accountants report liabilities on a balance sheet, which summarizes a company's assets and liabilities. Liabilities typically account for over half of a company's balance sheet, and they can be broadly classified as current and noncurrent obligations.

Current Liabilities

Accountants must first present current or short-term liabilities in the liability section of a company's balance sheet. These short-term liabilities are obligations that are due within a year. Short-term liabilities include accounts payable to vendors, short-term borrowing, the short-term portion of long-term debt, income and property taxes. Typically, the book value of current liability on a balance sheet approximates its financial estimate of market value.

Noncurrent and Contingent Liabilities

Noncurrent liabilities include long-term debt and other long-term liabilities. Long-term debt typically takes two forms: loans and bonds. Accountants may disclose all other long-term liabilities either separately or in one line-item, depending on how material their aggregate amount is. Other long-term liabilities include capital leases, pension obligations and health care benefits. Also, firms sometimes book contingent liabilities under the other long-term liabilities that represent a potential obligation due to be confirmed as a liability upon occurrence of a certain event. Companies must first evaluate if it is probable that a contingent liability will arise and there is a reasonable estimate of its value. Contingent liabilities can happen as a result of lawsuit outcomes and clean-up costs associated with removing pollution.

Accounting for Liabilities

When an obligation arises, a company records a credit balance in one of its liability accounts. The offsetting debit entry typically goes to either an asset or expense account, depending on the liability. For example, a retailer that receives inventory from a vendor records credit to accounts payable and debit to inventory. When the company makes a payment to the vendor, it reverses the accounts payable with a debit entry and books credit to the cash account. Also, if a company owes wages to its workers, its accountants record a credit entry to the accrued wages account and a debit entry to the wage expense account.

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