Liabilities in financial accounting are the financial obligations which a company has to pay. The liabilities are classified into two types. One is current liabilities and the other is non-current liabilities. Current liabilities are those liabilities that are due within a year, whereas non-current liabilities are longer-time liabilities that are due after a year. Current liabilities are also known as short-term liabilities, and non-current liabilities are also known as long-term liabilities.
In a balance sheet, first of all, assets are listed. After the assets, liabilities are listed. In the liabilities section of the balance sheet, first of all, current liabilities are listed, and then non-current liabilities.
The current and non-current liabilities can be further expanded to give an account of where the current and non-current liabilities are arising from. Are these short-term loans, long-term loans, accounts payable, account receivables, and bonds, etc.
The short-term or current liabilities are listed first in a balance sheet because these liabilities have the first claim on the assets of the company. Then, the long-term or non-current liabilities are listed, because they have the second claim on the assets of the company.
The liabilities are divided into two main parts because it makes it simpler to divide them based on their size, and the time at which they are due. Classification is done because it makes it easier to analyze and manage liabilities.
The company knows which liabilities are due, where to focus on the financial liabilities. Furthermore, companies can also analyze whether they have the capacity to take on new liabilities.
Consider a company which is planning to borrow to build a new factory. The size of the factory depends upon how much the company can borrow without overburdening its balance sheet. This is supposed to be a long-term project.
So, the company needs to analyze how much are its non-current liabilities, so it can accurately determine the size of capital it could borrow in the markets. This is why the classifications are so important because the companies can better analyze their own liabilities this way.
Analysts can also understand how much healthy or bad a company’s financial health is by analyzing the liabilities.
Types of current liabilities
There are multiple types of current liabilities. The main ones are shown in figure 1 below:
The four main types of current liabilities are accounts payable, short-term debt, taxes, and accrued expenses. All four types are explained in great detail below:
Accounts payables are the payments that a company has to make to its suppliers. The average time for these liabilities is anywhere between one to three months. Account payables are also classified as short-term debt because until it is paid for the product or service provided by the supplier is on credit to the buyer.
Some suppliers offer special discounts to buyers if they pay earlier. Whereas, the buyer wants to extend the time for payment as much as possible to improve the cash position on its balance sheet.
Short-term is the debt that is due within a year. That is why short-term debt is classified as a current liability in the balance sheet. The company borrows short-term debt when it is expecting to incur a huge loss, or the economic conditions are not right, as a result, it is a good idea to borrow short-term debt to tide over any uncertain economic condition. This can be the difference between companies surviving or going bankrupt.
Every year companies have to pay taxes. As all taxes are due within a year, taxes are classified as current liabilities. Sometimes, there are some deferred taxes that are considered non-current liabilities. Some types of examples of taxes that are considered as current liabilities are income taxes, payroll taxes, and sales taxes.
Accrued expenses are those expenses that are recorded in the books, but are yet to be paid. The accrued expenses are the opposite of accrued revenue. These expenses are only recognized at the end of an accounting period when they are paid for or are cleared. Until then, accrued expenses are listed as current liabilities in the balance sheet. Some examples of accrued expenses are invoices payments, interest payments, and property taxes.
Types of non-current liabilities
Non-current liabilities are long-term liabilities. There are multiple types of non-current liabilities, the main ones are shown below in figure 2:
Figure 2: Types of non-current liabilities
There are four types of non-current liabilities shown in figure 2. These four types are provisions, long-term debt, deferred taxes liabilities, and Lease obligations. All four of these types are explained in detail below:
Provisions are capital that companies put in a separate account, so if in any case, any unexpected loss occurs, these provisions can cover the losses. Furthermore, sometimes expenses of one year are recognized in another year, and provision is required to cover these expenses. The provision account thus provides money to the clearing account to take care of any unexpected expenses which may arise.
Companies usually borrow long-term debt to finance new projects which may have a timeline of multiple years. These new projects may be factories, new buildings, or expanding older factories. For these types of projects, companies borrow on long-term horizons. As the payment of this type of debt is also over multiple years, the long-term debt is that’s why recognized as a non-current liability.
Deferred taxes liability
The deferred tax liability arises from the fact that when the taxes are recognized as liability, and when these taxes are paid happens in different accounting periods. This period can last for more than a year, and as these taxes are deferred it means that these taxes are classified as non-current liabilities.
It is basically a record in the balance sheets of a company that it will have to pay these taxes in the future.
Lease obligations are the obligations related to the lease. Whether the lease is of a building or equipment, or any other type of capital, the leases are usually signed for more than a year. This makes these leases non-current liabilities. Usually, the time period for a lease is when the capital is depreciated to about 25% of its original value. This can occur over multiple years.
Frequently asked questions
How may a liability be classified as current or non-current?
Liabilities are classified as current or non-current liabilities based on the time period during which they are due. If the liabilities are due within a year, then these liabilities are classified as current liabilities, and if these liabilities are due after a year, then these liabilities are classified as non-current liabilities. Current liabilities are also known as short-term liabilities, and non-current liabilities are also known as long-term liabilities.
What are Non-current financial liabilities?
The non-current financial liabilities are long-term debt obligations, deferred tax payments, long-term lease obligations, provisions, and secured/ unsecured loans. There are also some other types of non-current financial liabilities, but the ones stated above are all the main ones. The non-current financial liabilities are those liabilities that are due in multi-years time, so any financial liability that is due after a year can be classified as a non-current financial liability.
Is rent included in current liabilities?
Rent can be classified as a current liability if it is due within a year. For most people, rent is a current liability, because they have to pay rent every month, and every obligation or financial liability is classified as a current liability if it is due within a year, so rent can be classified as a current liability.
Sometimes, the company leases equipment that has a multiple-year contract. In this case, the lease is classified as a non-current liability.