Liability is defined as the following:

A liability is a present obligation of the entity that arises from past events. The settlement of the liability is expected to result in an outflow from the entity in the form of resources such as assets, providing a service or payment of an account.

Explanation

A liability is an obligation of the entity to transfer cash or other resources to another party.

It could be (as an example) a bank loan. The bank loan obligates the entity to pay loan installments over the duration of the loan to the financial institution along with the associated interest cost. Alternatively, an entity’s liability could be a trade payable arising from the purchase of goods from a supplier on credit.

Classification:

Liabilities may be classified into Current and Non-Current. It is determined on the basis of the time period within the liability is expected to be settled.

Current Liability is one which the entity expects to pay off within one year from the reporting date.

Non-Current Liability is one which the entity expects to settle after one year from the reporting date.

Types and examples of liabilities:

These are the most common types of liabilities along with their classifications:

Liability

Classification

Long Term Bank Loan Non-current
Bank Overdraft current
Short Term Bank Loan current
Trade Payables current
Debenture Non-current
Tax Payable Current

It may be appropriate to break up a single liability into their current and non current portions. For instance, a bank loan spanning two years and carrying 2 equal installments payable at the end of each year would be classified half as current and half as non-current liability at the inception of loan.

Where do you use liabilities?

Where it appears in the Financial Statements
Liabilities are included in the Balance Sheet. It is a requirement and a fundamental part of your accounting equation:

  • Assets = Liabilities + Owner’s Equity.

This is the equation on which the Balance Sheet is based upon.