Liabilities: Meaning and Classification of Liabilities

Liability is something which a person owes to another. It is an obligation that should be met by the liable party as a result of any activity or transaction entered into by the two parties.

At times, a liability can be merely a responsibility or sense of feeling shown by one person to another in place of sheer love or gratitude. For example, performing the marriage of a daughter or donating money to some social cause periodically, or even frequently, can be felt as a liability.

But, for accounting purposes, a liability is to be defined as an obligation or responsibility of a person or any business entity to the other party as a result of a transaction or contract. 

It is an unavoidable obligation to be fulfilled by the party concerned to his creditors or other parties on the maturity of a certain period, or on the occurrence of an event, or the achievement of a certain goal or target.

Liabilities, in accounts, are mostly monetary and expressed in money values. Though goods can be exchanged between parties to meet out liabilities, they should be evaluated and expressed in the books in money values.

Classification of Liabilities

Liabilities are generally classified into three major groups:

1) Current Liabilities

2) Long-Term Liabilities

3) Contingent Liabilities

Now let us take a look at the nature and identification of these three classes of liabilities.

Current Liabilities

Current liabilities are also known as short-term liabilities due to their short duration. A current liability signifies the priority involved in the clearance of the liability. Such a liability is considered to be cleared within a specific short period, say within 3 months or 6 months. You will have to clear them within that short range of period. Some of them may even become due within days, say within 3 days, 7 days, or a month like that. 

Any type of borrowing or credit taken to meet your daily needs of business falls under this category, and they are to be cleared first. Salaries and taxes payable are such urgently payable short-term liabilities. Besides, bank overdrafts, short-term credits, like credit cards, and credit purchases are also examples of this category.

Long-Term Liabilities 

From the name itself, you are able to see that these liabilities are of long-term or for longer durations. Normally, such liabilities are cleared in many years, and the terms of repayment are set forth at the time of obtaining the funds or during execution of the contract. Bank loans for long periods, mortgages, etc. fall under this category.

Contingent Liabilities 

This category of liability depends on the occurrence of a contingency. That is, its settlement is tied to the occurrence of an event or incident. If the specified event occurs, it becomes due and payable immediately upon that happening. If the stated incident does not occur at all, it is not required to be settled.

So, a contingent liability means that it shall be met only on the occurrence of a certain incident. The time of that occurrence is neither known nor certain. 

There can be other unexpected incidents like a breach of contract, damage due to accidents, and/ or court cases which are also treated as contingent liabilities.

For accounting purposes, only current liabilities and long-term liabilities are considered in the Balance sheets. 

Contingent liabilities are merely mentioned in the notes as a supplement to the Balance Sheet for the information of the Board of Directors and Shareholders.