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Liabilities in Accounting: Definition, Examples & Quiz

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Taught by

Shawn Grimsley

Every business has liabilities. In this lesson, you'll learn what liabilities are and how they fit into the overall financial picture of a business, and you'll be provided some examples. You'll also have a chance to take a short quiz.

Definition

Liabilities are financial obligations a business owes to other persons, businesses and governments. Short-term liabilities are financial obligations that become due within a year, while long-term liabilities are due in a year or longer. A company's total liabilities is the sum of its short-term and long-term liabilities. Liabilities are reported on a company's balance sheet along with its assets and owners' equity.

You should keep in mind that liabilities are financial obligations, not just debt. All debts are financial obligations, but not all financial obligations are debts. For example, let's say you lease a small retail space downtown and must pay rent on a monthly basis and not in arrears - in other words, May's rent is due on May 1, not June 1. Your rent obligation is a financial obligation, and therefore a liability, but it is not a debt because you pay for the use of the property for the month before you use it. If you don't pay your rent on time, it becomes a debt.

Liabilities and the Basic Accounting Equation

Liabilities is one of the three components of the basic accounting equation: Assets = Liabilities + Equity. Assets are the value of the property owned by a company, equity is the owner's capital in the company, and liabilities, as you know, are the financial obligations of the business. If you perform the relevant algebraic operation on the equation, you will come up with the formula for determining liabilities: Liabilities = Assets - Equity.

Examples

Let's look at some examples of liabilities. We'll break them down into long-term and short-term liabilities.

Short-Term Liabilities

  • Short-term notes payable - loans that come due in less than one year
  • Accounts payable - money owned for goods and services provided to the business
  • Dividends payable - dividends that have been announced but not yet paid to shareholders
  • Sales taxes
  • Federal income taxes
  • State income taxes
  • Wages and salaries
  • Payroll taxes
  • Retirement benefits

Long-term liabilities

  • Credit line - a revolving credit account that allows you to draw upon the line for money as needed up to a set limit for a set period of time
  • Long-term note payable - loans that are due in a year or longer
  • Bonds - negotiable debt securities that are issued to investors to raise money

Summary

Liabilities are the financial obligations owed by a business to other persons, businesses, and governments. Long-term liabilities are obligations that are due in a year or longer, while short-term liabilities come due within a year. Liabilities are reported on the company's balance sheet and are also one of the three components of the basic accounting equation.

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