Wednesday, October 13, 2010
A Liability is a legal obligation of a business to pay a debt. Debt can be paid with money, goods, or services, but is usually paid in cash. The most common liabilities are notes payable and accounts payable. Accounts payable is an unwritten promise to pay suppliers or lenders specified sums of money at a definite future date.
Current Liabilities are liabilities that are due within a relatively short period of time. The term Current Liability is used to designate obligations whose payment is expected to require the use of existing current assets. Among current liabilities are Accounts Payable, Notes Payable, and Accrued Expenses. These are exactly like their receivable counterparts except the debtor-creditor relationship is reversed.
Accounts Payable is generally a liability resulting from buying goods and services on credit
Suppose a business borrows $5,000 from the bank for a 90-day period. When the money is borrowed, the business has incurred a liability – a Note Payable. The bank may require a written promise to pay before lending any amount although there are many credit plans, such as revolving credit where the promise to pay back is not in note form.
On the other hand, suppose the business purchases supplies from the ABC Company for $1,000 and agrees to pay within 30 days. Upon acquiring title to the goods, the business has a liability – an Account Payable – to the ABC Company.
In both cases, the business has become a debtor and owes money to a creditor. Other current liabilities commonly found on the balance sheet include salaries payable and taxes payable.
Another type of current liability is Accrued Expenses. These are expenses that have been incurred but the bills have not been received
for it. Interest, taxes, and wages are some examples of expenses that will have to be paid in the near future.
Long-Term Liabilities are obligations that will not become due for a comparatively long period of time. The usual rule of thumb is that long-term liabilities are not due within one year. These include such things as bonds payable, mortgage note payable, and any other debts that do not have to be paid within one year.
You should note that as the long-term obligations come within the one-year range they become Current Liabilities. For example, mortgage is a long-term debt and payment is spread over a number of years. However, the installment due within one year of the date of the balance sheet is classified as a current liability.