Q:What are liabilities in accounting?
A:We likely all are familiar with liabilities in our personal life. Debts such as mortgages or car loans are example of common personal liabilities that individuals routinely pay. However, what are liabilities in terms of accounting. Let’s get into it below.
Liabilities in accounting are debts that are due to be paid to creditors or suppliers by a business. They are also prepaid accounts that the business has received payment for, but has not performed the service or supplied the product. Ultimately, liabilities result from the operations of a company.
Liabilities are reported on the balance sheet with current liabilities listed first and long-term liabilities appearing second. Current liabilities are due to be paid with 12 months. Long-term liabilities are those accounts that are due to be paid over a year.
Keep in mind that when it comes to accounting, the accounting equation always applies. This equation is Assets = Liabilities + Owner’s Equity. This means that assets can either be financed by debt or paid through the equity of the company. If you examine a balance sheet, you will notice that it is a reflection of the accounting equation featuring not only the business liabilities but also the assets and stockholder’s equity.
Examples of Accounting Liabilities
Let’s take a look at some common examples of liabilities that appear on the balance sheet:
Accounts Payable: This is a liability that a company owes for goods or services. The goods or services have been delivered to the business, but payment has not been made. For example, a shoe store may order an assortment of shoes from a supplier. The supplier sends the shoes and allows the shoe store 30 days for payment of the shipment. Since the shipment has not been paid, it will be considered an accounts payable liability for the shoe store until the payment in made in full.
Notes Payable: When a business takes out a loan and signs a promissory note, it is considered a notes payable. The business formally agrees in writing to pay back a certain amount indicated on the note within a stated period. This differs from an accounts payable because the accounts payable does not involve a written promissory note.
Wages Payable: This is the amount due to be paid to employees for time worked. It represents wages that have not yet been paid.
Interest Payable: Interest payable represents interest that has not yet been paid, but is owed or has been accrued. For example, assume a company acquired a loan on October 31 and interest is due annually on January 1st. The company would record interest payable for November and December. When the payment of interest was made on January 1st, the interest payable would be zero. It is important to keep in mind that interest payable does not include future interest, but rather interest that has already accrued.
Taxes Payable: Similar to interest payable, taxes payable is the amount that has accumulated for the tax payment, but has not yet been paid. This does not represent future tax payments, but the amount that is due as of the balance sheet date.
Unearned Revenue: Many people just starting to learn accounting assume that unearned revenue is a current asset. However, it is actually a current liability that appears on the balance sheet. Unearned revenue is the amount received as payment for a good or service when the business has yet to perform the service or provide the good. Essentially, it is a prepayment by the person or business purchasing the good or service.
Warranty Payable: When a company offers a warranty on a product, they expect that a certain number of products to be returned because of defects. Warranty payable is the amount that a company projects it will need to spend to address the estimated defects.