What is Liability? The following is the definition and some examples

Accounting is the method by which businesses keep track of their financial transactions, assets and liabilities. Liabilities are transactions that offer a close look at the operational efforts of a business. In this article, we will tell you about what a liability is, the importance of this transaction and share some examples of liabilities that exist in a business.


1 What is Liability and Why is it Important?
2 What are the Types of Liabilities?
3 Examples of Liabilities in a Business
3.1 Debt account
3.2 Accrued liabilities
3.3 Unearned income
3.4 Salary debt
3.5 Bank transfer account
3.6 Dividend payable
3.7 Withholding employee income tax
3.8 State income tax
3.9 Savings account
3.10 Potential lawsuits
3.11 Product warranty
3.12 Mortgage payable
4 Difference between Liabilities and Expense

What is Liability and Why is it Important?

A liability or obligation is something that is owed from one party to another. It is an obligation to exchange goods, money or services.

Companies use liability accounts to keep records of outstanding balances to vendors, customers, or employees. As part of the balance sheet, it gives shareholders an idea of ​​the health of the company.

Liabilities are an important aspect of supply and demand in the economy. The producer supplies the product, and the consumer makes an obligation to pay for the product. This leads to an open flow of money and a continuous cycle.

To know the meaning of liability in more depth, you can read it through this article.

What are the Types of Liabilities?

After knowing what a liability is, the next step is knowing the type of liability.

Liabilities are incurred as a normal part of the business and are recorded on the right side of the balance sheet as a deduction from assets. As capital flows into and out of the business, a liability or liability is recorded and paid. Liabilities can be classified in three ways:

Non-current liabilities: Non-current liabilities are also called long-term liabilities. Long-term liabilities are money owed to other parties that are not due within 12 months. Non-current liabilities are usually loans, pensions and other things of the same nature.

Current liabilities: Current liabilities—also called short-term liabilities—are those that are due within one year. They occur most frequently of the three classifications.

Contingent liabilities: Contingent liabilities arise as a result of special circumstances. These obligations are generally rare and unexpected. In some cases, a contingent liability is recorded when the company expects a transaction to occur but does not yet know the date or amount of the transaction.

Example of Liability in a Business

The following are some common examples of liabilities in various industries:

Accounts payable

Accounts payable is the part of a company’s general ledger that reflects the amount the business pays for goods and services received but not yet paid. Accounts payable arise when invoices are received. Invoices come from suppliers, vendors, or other businesses for goods or services rendered.

On the balance sheet, accounts payable appear as the sum of all amounts owed. The increase or decrease in trade payables from the previous accounting period is reflected in the statement of cash flows to shareholders.

Accrued liabilities

Accrued liabilities occur when a business faces unbilled expenses. They can be classified as short-term or long-term liabilities.

Even though no funds are exchanged, entries are made to have a record of the expenses in the accounting period in which they occur. The accounting software will generate automatic reversing entries to cancel accruals when invoices are received. Purchase orders are usually used to get accrued amounts.

Examples of accrued liabilities:

  • Loans
  • Pension plan benefits
  • payroll tax
  • Compensation payable to employees at the end of the accounting period but not due until the next period

what is liability

Prepaid income

Unearned revenue is an example of a current liability in which services are payable, not money. Revenue is an advance that is contingent on the future exchange of goods or services.

After the agreement is fulfilled, an offsetting entry is made and the liability is recognized as revenue. Examples of unearned income are:

  • Advanced fees for legal services
  • Prepaid insurance
  • Rent is paid in advance
  • Payment for subscription services

Salary debt

Salaries payable is a current liability account of the amount owed to employees in the next payroll cycle. In other words, this is the amount owed to the employee that has not been paid. This amount is reflected on the balance sheet and increases with credit entries and decreases with debit entries.

Salaries payable are different from the salary expense shown on the income statement. Salary expense is the full amount paid to all salaried employees in a given period while accounts payable is only the amount owed at the end of the period.

Bank transfer account

Overdrafts are small advances made by banks to prevent business transactions from being rejected. This happens when the amount in the account drops below zero.

Overdrafts or commonly known as overdrafts are current liabilities. Since it is considered a short-term loan, it is not uncommon for businesses to treat it as positive cash flow until it is paid off. This generally occurs when an overdraft occurs at the end of a period.

Dividend debt

Dividends are money paid to the shareholders of the organization. When profits are allocated, dividends are paid to investors by the percentage of shares they own in the company. Until the funds are distributed, a dividend payable account is opened as a current liability.

Employee income tax deduction

Organizations that have employees are legally obligated to pay taxes to the Indonesian government. Withholding employee income tax is the amount the employer must pay the government after each payment cycle. In Indonesia, several deductions apply to:

  • Income tax
  • BPJS of Employment

State income tax

Depending on the type of business, the company may have to pay additional taxes. The frequency of payment of state income depends on the size of the business and is determined by PSAK.

Savings account

Another example of a current liability is a savings account. For account holders, cash is a current asset. For banks, a savings account is a current liability because cash is money that the bank borrows from the account holder.

Potential lawsuits

A potential lawsuit is an example of a contingent liability. Pending lawsuits are usually recorded as a footnote to the financial statements. To be recognized, it must meet two conditions:

  • The amount of payment can be reasonably estimated
  • The lawsuit might happen

Product warranty

A product warranty is another example of a contingent liability because the issuing company can only estimate how much product will be returned.

Companies issue warranties to customers but customers rarely charge them. The business records the estimated amount as an increase (debit) for warranty costs and as an increase (credit) for contingent liabilities.

At the end of the accounting period, the accounts are adjusted to reflect the true number of honored guarantee recipients.

Mortgage debt

A mortgage is a loan for ownership of an asset such as land, property or buildings. Mortgage loans consist of three sections that are classified differently in the financial statements:

  • Flower
  • Amount to be paid within 12 months
  • The balance of the loan principal

Interest on the loan is considered an expense and is recorded in the income statement. The amount of the loan that must be repaid within 12 months is considered a current liability. The remaining principal of the loan is considered a non-current long-term liability.

Mortgages paid on the required day of the month are usually considered an expense for that month.

Difference between Liabilities and Expense

Although they both reflect cash flows out of an organization, costs and liabilities have a key difference. Expenses are reductions in income and liabilities or liabilities are reductions in assets.

Expenses are expenses incurred to keep the business functioning on a day-to-day basis. They are usually recurring, or so-called monthly expenses. Liabilities are a reflection of what is owed in the future.

Some examples of loads are:

  • Salary
  • Utilities
  • rent
  • The basic selling price
  • Insurance
  • Training
  • Software subscription

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