Types of liabilities in accounting, with examples
A liability is what the business owes — to suppliers, to banks, to the government, and to its own owner. Long-term, current and contingent liabilities explained with examples a trader will recognise.
A liability is an amount the business owes and will have to settle — by paying money, by delivering goods, or by doing a service. Buying cloth on 60 days' credit creates a liability the day the cloth arrives, not the day the cheque is written.
Capital — what the business owes its owner
This surprises people: the owner's capital sits on the liabilities side. The business and the owner are kept as two separate persons in the books, so money the owner put in is money the business owes back. Profit is added to it, drawings are taken off it.
Long-term (non-current) liabilities
Owed, but not due within the coming year.
- Term loan from a bank for machinery, repaid over five years.
- Vehicle loan.
- Loan against property.
- Unsecured loans from family, friends or partners that are not repayable on demand.
Current liabilities
Due within about a year. These are the ones that decide whether the business can pay its way next month.
- Sundry creditors — suppliers of cloth, yarn, processing and transport who have not been paid.
- Bank overdraft or cash credit — the amount drawn against the limit.
- GST payable — tax collected on sales, less input credit, not yet deposited.
- TDS payable — tax deducted from somebody's bill and not yet paid to the government.
- Outstanding expenses — salary, rent or electricity for the month that is over but unpaid.
- Advances from customers — money received before the goods were sent.
- The part of a long-term loan that falls due in the next twelve months.
Provisions
An amount set aside for something that is certain to cost money, though the exact figure is not known yet: income tax for the year, an audit fee, a bonus that will be declared at Diwali. It is charged to this year's profit because it belongs to this year.
Contingent liabilities — owed only IF something happens
These are not entered in the books at all. They are written as a note under the balance sheet, so that anybody reading it knows they exist.
- A tax demand that you have disputed in appeal.
- A guarantee you have given for somebody else's loan.
- A bill discounted with the bank that the customer has not yet paid.
- A court case where the other side is claiming damages.
One business, sorted
| What the business owes | Kind of liability | When it is due |
|---|---|---|
| Owner brought in ₹20,00,000 | Capital | Only when the business is closed or the owner withdraws |
| Machinery term loan, ₹12,00,000 | Long-term | Over five years |
| Next 12 instalments of that loan | Current | Within the year |
| Grey supplier's bills, ₹4,90,390 | Current (creditor) | On the credit days agreed |
| GST for September, ₹38,000 | Current (duties and taxes) | Next month |
| Advance from a customer, ₹1,00,000 | Current | When the goods are delivered |
| Disputed sales-tax demand of ₹2,40,000 | Contingent | Only if the appeal is lost |
Mistakes we see most often
- Booking a customer's advance as a sale. Until the goods go, it is money you owe. Booked as a sale it inflates profit and GST turnover in the wrong month.
- Showing input GST as a negative liability. Input credit is money the department owes you — an asset. Netted into "Duties and Taxes" it makes both sides of the balance sheet smaller than they are.
- Forgetting expenses that are due but unpaid. March salary paid in April is a liability on 31 March. Left out, March looks cheaper and April dearer than they were.
- Leaving a customer with a credit balance inside debtors. A customer who has overpaid is somebody you owe.
Why the split between long-term and current matters Current assets divided by current liabilities is the current ratio. Below 1, the business owes more in the coming year than it expects to collect — and that is worth knowing before the bank asks.