Understanding Liabilities in the Balance Sheet: Classification, Recognition, Measurement and More

Liabilities in a Balance sheet are the commitments of the company to external parties. These are categorized as current (payable under 12 months) and non-current (payable in more than 12 months) liabilities. Defined under the IFRS: “A company’s present liability is the obligation stemming from previous events, which are to result in an outflow of resources which reflect the economic advantages of a business.”

Classification of Liabilities

Three main categories of liabilities exist:

  • Current Liabilities
  • Non-current Liabilities
  • Contingent Liabilities

These are the legal duties or debts payable to a person or organization. This means that liabilities represent future sacrifices of economic advantages to other entities owing to previous events or transactions that an entity must fulfill.

Current Liabilities

Current liabilities are debts or commitments that have to be payable within a year and are also known as shorter-term/short-term/current liabilities. The management must continually check current liabilities to ensure that the firm has adequate liquidity from current assets to ensure that the debts or commitments are fulfilled. In several short-term liquidity metrics, current liabilities are employed as a significant element.

Short-term loans, accrued expenses, bank overdrafts, bills payable, income tax payables, and interest payables are some examples of current liabilities.

Non-current Liabilities

Non-current/longer-term liabilities are debts or commitments due over the course of one year, sometimes called long-term liabilities. Long-term liabilities are a major element of the long-term financing of a firm. Companies acquire long-term loans to acquire quick money to finance equity or invest in new capital projects. In assessing a company’s long-term solvency, long-term liabilities are essential. Unless firms can reimburse their long-term commitments, the company will suffer a solvency issue.

Capital leases, long-term notes payable, mortgage payable, deferred tax liabilities, and bond payables are examples of long-term liability.

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Contingent Liability

Contingent liabilities shall be a specific liability category. Depending on the outcome of an uncertain future occurrence, they are likely obligations that may or may not arise. A contingent liability shall only be recognized if the following two conditions are fulfilled:

  1. The result is likely.
  2. The quantity of obligation can be assessed fairly.

If one of the elements is not met, a corporation shall not report on its balance sheet a contingent liability. However, in a footnote on the financial statements, it should disclose this item.

Legal liabilities are one of the most common instances of contingent liabilities. Imagine a firm participating in the proceedings. The corporation expects to lose the case in court, resulting in legal fees based on better evidence supplied by the other party. Contingent liabilities for legal fees can be identified because:

  1. The cost is likely.
  2. The legal costs can be predicted reasonably (based on the remedies asked by the opposite party)

Recognition of Liabilities

An entity can only recognize liabilities in the balance sheet if:

  • Past events or transactions result in liabilities.
  • The company is legally responsible for such transactions or events.
  • When settled, an entity will have an economic outflow.

Contract commitments equally unfilled, e.g., inventory obligations ordered but not still received, are typically not considered liabilities on the practice’s financial statements. Such obligations may nonetheless comply with the definition of liabilities and may be eligible for recognition, provided the recognition requirements are fulfilled in the specific circumstances. Recognition of liabilities involves recognizing related assets or costs in these instances.

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Measurement of Liabilities

Liabilities must be measured according to the cost principle. When liability is originally formed, the quantity of liability equals the current market worth of the resources obtained at the transaction time. In most instances, the liabilities are quantified in their main amounts and then documented and reported.

Measurement of Liabilities can be assessed at;

  1. At their historical worth, that is, at the value linked to their contractual basis in line with accounting agreements.
  2. At their discounted net values that are typically recognized in economics according to the way in which assets are evaluated.

The current liabilities are those which are payable within one year. These occur mainly as part of ordinary business activities. Because of the short-term nature of these financial obligations, the organization’s liquidity should be taken into consideration. The liquidity ratio between current assets and current liabilities is frequently determined. Following current liabilities are the most common:

Accounts payable: These are the unpaid bills to the vendors of the company. In general, the most current liability for most firms is the accounts payable.

Interest payable: Interest expenses already incurred but not paid. The payable interest should not be confused with the interest costs. In contrast to the interest payable, interest costs are already incurred and paid expenses. Interest expenditure is therefore included in the income statement while interest on the balance sheet.

Revenue taxes payable: The amount of income tax owed to the government by a company. The amount of tax owed must be paid in a year. Otherwise, a long-term responsibility should be classified as the tax owed.

Bank account overdrafts: A form of short-term credit from a bank when insufficient cash on the bank account is processed.

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Accumulated Expenses: Incurred expenses but did not obtain or produce supporting documents (e.g., invoice).

Short-term loans: Loans maturing in one year or less.

Long-term liabilities (non-current) are those payable more than a year later. Long-term liabilities should not include short-term payments due to interest payable. It is important. Long-term liabilities can be a financing source and may include amounts resulting from corporate activities. For example, bonds or mortgages can be utilized to finance the company’s large-scale projects. The general liquidity and capital structure of a corporation must be understood through liabilities. Long-term liabilities include:

Payable Bonds: The number of outstanding bonds issued by a firm with a maturity of more than one year. The bonds due account on a balance sheet shows the face value of the company’s outstanding bonds.

Notes payable: Amount of average notes issued by a corporation for more than one year. The balance sheet notes payable represent the face value of the promissory notes in a way similar to bonds payable.

Delayed tax obligations: The disparity between the tax amount recognized and the actual tax amount paid to the authorities is a result. It indicates that the corporation “underpaid” taxes in the present period and will at some point in the future “overpay” taxes.

Mortgage due/long-term debt: When an enterprise gets a debt or a loan, the face value is recorded in the balance sheet of the borrowed capital as a non-current debt.

Capital lease: When a corporation engages in a long-stay rental contract for equipment, capital leases are considered liabilities. A present value of the rental obligation is the amount of the capital lease.