Liability is a legal obligation of an individual or a business entity towards creditors arising out of some transactions. A more clear-cut definition of liability signifies it as a claim by the creditors against the assets and legal obligations of an individual or entity resulting from the past or current transactions and events.
Types of Liabilities
Liabilities imply a duty or responsibility to pay on demand or on an occurrence of certain transaction or event. Liabilities also arise from borrowings which may be made to improve business or personal income and are paid back over an agreed period of an interval, which may be of the short period or long period.
Liabilities are mentioned on the left-hand side of a Balance Sheet below Equity Capital. Just like assets, liabilities are also represented in a sequence in the Balance Sheet. Liabilities are grouped and classified according to their nature and time period. Some common types of liabilities include current liabilities, long-term liabilities and contingent liabilities. Let us have a look at them:
Current Liabilities or Short Term Liabilities
Liabilities which are normally due and payable within one year are grouped as current liabilities. These liabilities are also known as short-term liabilities as they become due within a shorter period (say within 1 year). Creditors, salaries and wages payable, gratuity or bonus payable, interest payable, bills payable, sundry creditors, bank overdraft or cash credit, unclaimed dividends, pre-received incomes, sales tax payable, income tax payable, provisions, other taxes payable, accrued expenses, instalments due within 1 year for term loans, etc. are all examples of current liabilities.
Long Term Liabilities
Liabilities which are not immediately due but become due after a year or more are classified as long-term liabilities. Long term bank loans like term loans, debentures, deferred tax liabilities, mortgage liabilities (payable after 1 year), lease payments examples of long-term liabilities. Interest payable is also treated as the long-term liability if interest is payable on maturity.
Certain liabilities are payable on the occurrence of some event or contingency. Contingency signifies something which may or may not take place. If a liability is due on happening of such an event, it is termed as the contingent liability. Default in supply, breach of contract, damage to the environment or to the prestige of some person or entity, an outcome of accidents and other law-suits, are examples of some such cases where a liability is contingent to occur. Such liabilities are calculated on the basis of “what if the actual loss occurs” where ever possible and with an addition of a notional calculation of damage occurred to the person or entity. Generally, these liabilities are not included in the Balance Sheet but are mentioned separately as a note to the balance sheet.