Basic Accounting: What is a Liability?
We touched briefly on liability in a previous article, and we mentioned it again during our asset discussion. But what and how do we classify something as a liability?
A liability is something for which we are responsible. Liabilities are not just loans; they can be homework assignments, study material, or our little brother on Saturday night. In the world of finance, accounting and banking, a liability has an assigned monetary value and we are responsible for repayment of that amount in some way.
How does this work? Well, suppose you want to buy a car. The cost of the car exceeds the money you have in your sock drawer, so what do you do? You (actually your parents) would go to the bank, and ask to borrow enough money to purchase the car. In requesting to borrow money, you are creating a loan liability. In other words, the bank expects you to repay the money, over a specific period of time with interest.
This unfortunately is the greatest drawback to acquiring assets: we generally must borrow the money to purchase those assets, and then repay the money we borrowed. In your personal life, if your liabilities exceed your assets and your ability to repay, you may have to consider filing bankruptcy. This is a bad thing for your credit report (something we will discuss later) and tends to have a negative effect on our lives. In business, the effect is bad for your business livelihood,
but not necessarily your personal livelihood.
What about a business liability? How is this different from a personal liability? Not really that much different, except that often these liabilities are for much greater amounts of money, and very few items purchased for a business will be acquired without the funding from borrowed money.
Liabilities are not just loans. When you operate a business, and you have employees you will be responsible for payroll taxes that must be paid on that employee. These are known as payroll liabilities. Credit issued to your customer for defective products or services is a liability until the customer uses the credit. Accounts payable in a business are a liability. They’re not loans in the traditional sense, but accounts payable are accounts for which the vendor has extended your business credit purchasing terms.
In other words, you can purchase the products, goods or services based on your credit rating, and pay for them in 30, 60, 90 day terms. Can you begin to see how your credit history, developed through your repayment of long term liabilities, can affect your ability to obtain future liabilities? It is a continual circle of a relationship. Assets, liabilities, and credit all affect and change each other.
As you can see, liabilities are like assets in that they are not simple, cut and dried objects. The only variant from a comparison of assets and liabilities is in the intangible area. Generally, a liability is not included in the intangible sense of the word.