LeoGlossary: Liability
In both finance and accounting, a liability is a debt owed by an individual or company. It is the legal obligations that require payment in the future.
A liability is a transference of future economic benefits. This reduces the value of a company since it is something owed. For this reason, the ratio of liabilities in relation to assets is something analysts and investors watch.
Examples of Liabilities:
Current versus Long Term
Current liabilities - those that are due in the next year such as wages or taxes
Long-term (non-current) liabilities - those not due until for at least a year; bonds offered by a corporation is an example.
Accounting
The liability is one of the basic entries in accounting.
It is placed on the balance sheet. They are listed on the right hand side with assets going on the left.
This is also one of the variables used to determine net worth. It applies to both individuals and the business. Shareholders and investors look at this when making their investment decisions.
The basic accounting equation is: assets - liabilities = net worth
Net worth is also called "shareholder equity".
Debits & Credits
Debits and credits have an impact on both sides of the balance sheet.
Debit - increases an asset or decreases a liability
Credit - decreases an asset or increases a liability
Double-entry accounting means that every financial transaction corresponds to both a debit and a credit. The asset side of the balance sheet always has to equal the liability plus net worth side.
If liabilities exceed assets, the individual or company is said to have a negative net worth.
Cash
Cash is an asset on the balance sheet of individuals and companies.
When it is deposited in a bank, this creates a liability for that institution. This is due to the fact that the money is owed to the depositor. When a withdrawal is made, the cash on hand is reduced along with the liability.
Capital Debt
In the capital markets, debt is a liability on the balance sheet of the one issuing it. This is effectively a loan made by the investors to the company. There is a stated interest rate which is the return to the investors.
Capital flows into the debt markets because it an asset to the holders of it.
This is similar have banks and financial institutions who offer loans operate. The same is true when debt is bundled and sold by Wall Street firms.
What is a Contingent Liability?
A contingent liability is a potential liability that may occur in the future. Companies can face the potential for future liabilities if they are in litigation or if they have issued product or service warranties that would need to be honored in the future. Contingent liabilities are not included on a balance sheet.
Contingency liabilities show up on company financial statements when they are likely to occur. It is also important that they can be estimated.
