What are the Main Types of Liabilities?
There are three primary types of liabilities: current, non-current, and contingent liabilities. Liabilities are legal obligations or debt owed to another person or company. In other words, liabilities are future sacrifices of economic benefits that an entity is required to make to other entities due to past events or past transactions.
Defined by the International Financial Reporting Standards (IFRS) Framework: “A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”
Classification of Liabilities
These are the three main classifications of liabilities:
- Current liabilities (short-term liabilities) are liabilities that are due and payable within one year.
- Non-current liabilities (long-term liabilities) are liabilities that are due after a year or more.
- Contingent liabilities are liabilities that may or may not arise, depending on a certain event.
Types of Liabilities: Current Liabilities
Current liabilities, also known as short-term liabilities, are debts or obligations that need to be paid within a year. Current liabilities should be closely watched by management to ensure that the company possesses enough liquidity from current assets to guarantee that the debts or obligations can be met.
Examples of current liabilities:
- Accounts payable
- Interest payable
- Income taxes payable
- Bills payable
- Bank account overdrafts
- Accrued expenses
- Short-term loans
Current liabilities are used as a key component in several short-term liquidity measures. Below are examples of metrics that management teams and investors look at when performing financial analysis of a company.
Examples of key ratios that use current liabilities are:
- The current ratio: Current assets divided by current liabilities
- The quick ratio: Current assets, minus inventory, divided by current liabilities
- The cash ratio: Cash and cash equivalents divided by current liabilities
Types of Liabilities: Non-current Liabilities
Non-current liabilities, also known as long-term liabilities, are debts or obligations due in over a year’s time. Long-term liabilities are an important part of a company’s long-term financing. Companies take on long-term debt to acquire immediate capital to fund the purchase of capital assets or invest in new capital projects.
Long-term liabilities are crucial in determining a company’s long-term solvency. If companies cannot repay their long-term liabilities as they become due, the company will face a solvency crisis.
List of non-current liabilities:
- Bonds payable
- Long-term notes payable
- Deferred tax liabilities
- Mortgage payable
- Capital leases
Types of Liabilities: Contingent Liabilities
Contingent liabilities are liabilities that may occur, depending on the outcome of a future event. Therefore, contingent liabilities are potential liabilities. For example, when a company is facing a lawsuit of $100,000, the company would incur a liability if the lawsuit proves successful.
However, if the lawsuit is not successful, then no liability would arise. In accounting standards, a contingent liability is only recorded if the liability is probable (defined as more than 50% likely to happen). The amount of the resulting liability can be reasonably estimated.
Examples of contingent liabilities:
- Product warranties
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