In the Conceptual Framework 2018 this is the definition: A liability is a present obligation of the entity to transfer an economic resource as a result of past events.
A liability is defined as a company’s legal financial debts or obligations that arise during the course of business operations. Liabilities are settled over time through the transfer of economic benefits including money, goods or services. Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues and accrued expenses.
Liabilities are a vital aspect of a company because they are used to finance operations and pay for large expansions. They can also make transactions between businesses more efficient. For example, in most cases, if a wine supplier sells a case of wine to a restaurant, it does not demand payment when it delivers the goods. Rather, it invoices the restaurant for the purchase to streamline the drop-off and make paying easier for the restaurant. The outstanding money that the restaurant owes to its wine supplier is considered a liability. In contrast, the wine supplier considers the money it is owed to be an asset.
For a liability to be accounted for in the financial statements of the reporting entity, these three criteria from the definition must all be satisfied:
- the reporting entity has an obligation,
- the obligation is to transfer an economic resource, and
- the obligation is a present obligation that exists as a result of past events.
In IAS 1 Presentation of Financial Statements the classification of liabilities is further explained and defined. In IAS 32 Financial instruments: Presentation the classification of financial instruments into assets, liabilities and equity instruments is regulated.
Examples of liability accounts in the statement of financial position are:
- Note payable,
- Accounts payable / Trade creditors / Trade payables,
- Salaries payable, Wages payable, Current and non-current liabilities
- Social securities payable
- Interest payable,
- Accrued expenses (payable)
- (Corporate) Income taxes payable,
- Customer deposits, Current and non-current liabilities
- Warranty liability,
- Lawsuit payable / claims payable,
- Deferred income, Unearned revenues,
- Bonds payable.
Contra liabilities are liability accounts with debit balances. (A debit balance in a liability account is contrary—or contra—to a liability account’s usual credit balance.) Examples of contra liability accounts include:
- Discount on Notes Payable Current and non-current liabilities
- Discount on Bonds Payable
- Debt Issue Costs
- Bond Issue Costs
Classifications Of Liabilities On The Balance Sheet
Liability and contra liability accounts are usually classified (put into distinct groupings, categories, or classifications) on the balance sheet. The liability classifications and their order of appearance on the balance sheet are:
- Current Liabilities – payable within 12 months after the applicable reporting date,
- Long Term Liabilities – payable later then 12 months after the applicable reporting date.