We live in a world of transactions and every transaction comes with a price or an obligation. A liability is that obligation, of an individual or an organization to pay out its debts, incurred in the course of work or business. In financial accounting, it is a debt incurred by an individual or an organization – where product or services have been delivered or been used but have not been paid for. This liability would exist until such time that this debt is paid, after which, it ceases to exist.
For business organizations, liabilities are usually recorded on a balance sheet and can be classified into two types.
• Current liabilities
• Long term liabilities
Current liabilities are those which are liquidated in a year, like wages to be paid, taxes and payment for purchase of equipment. Un-earned revenue has to be also adjusted along when calculating current liabilities. Long term liabilities are ones which are not expected to be paid off in on year. These include long term bonds, long term leases and pensions of employees.
Certain businesses have more liabilities than others like Insurance companies. While taking insurance, a person qualifies for liability to be borne by the company. For instance, if the person has car insurance and gets into an accident, it is the liability of the Insurer to make out payments for the repair of the car, pay for medical bills, pay for the damages of the third party and pay for the attorney’s fees as well, if legal counsel is needed. In addition to the regular liabilities of any business organization, an insurance company has to make sure that it fulfills the liabilities of its claims too. This is the reason why a lot of insurance companies charge more interest from insurance seekers who belong to any high risk category. If the chances of the insurance seeker, claiming damages increases drastically, so will the company’s liabilities.
Banks also work with a lot of liability. When we open a savings account in a bank, we deposit a certain amount of money. Though the money is with the bank, it is not recorded as an asset of the bank. It remains the asset of the account holder. The account holder can at anytime ask for the money and the bank has to make the amount available. It is therefore a liability of the bank. If an amount is credited to the bank, its liability increases. Similarly, its liability decreases if an amount is debited out of the bank. For this purpose, every bank has a liability account which accounts for all deposits coming into the bank. The amount is suitably decreased every time that a depositor’s account is debited of money.
When the liabilities of a business organization get ahead of its profits, it faces bankruptcy.
Liabilities exist for the common man too. Liabilities for an individual could be mortgage loans, car payments, line of credit and liens of any kind. Liabilities, big or small, exist for all. A fine balance between liabilities and available funds to fulfill them can lead to comfortable financial stability.