Unit VIII Essay: Principles of Accounting
A liability is an obligation of a firm that is derived from previous transactions that lead to a process that demands a flow of assets out of the firm but brings economic gain. It is termed as debt or duty to a financial payment that is associated with trading or business practices (Cade, Ikuta-Mendoza, & Koonce, 2016). It can be paid through funds, assets, or even human services. Liabilities can be grouped into various categories, which are relative to the payment method and lapse time. This material seeks to examine different types of liabilities, stating three main characteristics of liabilities, while giving emphasis to the significance of classifying liabilities into short-term and long-term.
Type of Liabilities
A company may be liable for various categories of financial obligations. The main three categories of liabilities include the current, non-current, and contingent liabilities. Current liabilities are financial obligations that ought to be cleared within one year (Podolianchuk, Plakhtii, & Gudzenko, 2019). Non-current liabilities are considered to be long-term (Hussey & Ong, 2017). They can be paid within more than a year or several years. Contingent liabilities, on another hand, are liabilities that may occur based on the results of a certain event in the future (Bova, Ruiz-Arranz, Toscani, & Ture, 2016). They are essential in business practices of financial projection in which an anticipated future event may result in liabilities. A contingent liability enables financial experts to determine the amount of funds that might be used if the event occurs. A good example could be when a company experiences some issues of warranty with some products offered to the customer in the future.
Primary Characteristics of Liabilities
One major characteristic of liabilities is that they are derived from previous business processes that involve trading and the growth of the firm. Such practices may include obtaining inventory on credit or seeking financial funding from a third party (Cade, Ikuta-Mendoza, & Koonce, 2016). Liabilities become due only after a business process that has led to an obligation by which the firm should consider financing or assets to cater to the commitment. This is an implication that a business process has to occur for the liabilities to be noted. Another significant characteristic of liabilities to business is that they result in a decrease in assets to be settled (Cade, Ikuta-Mendoza, & Koonce, 2016). Examples of assets that may be used to cater for a liability include funds, inventory, and so forth. Liabilities may also be settled through human capital. The third major characteristic of liabilities is that they are a current obligating that has to be settled in the future. Only contingent obligations are not current obligations, but they are also considered as current financial duties that the firm may meet in the future in the event of an anticipated future occasion that may result to financial liability.
Why Liabilities are classified into Short-Term and Long-Term
Liabilities should be classified into short term and long term obligations so that the firm can set aside the funds that should be used in clearing impending dues. The understanding and knowledge of liabilities can enable a firm to depend on a robust decision-making criterion and allows the firm to provide or take care of the obligations that are current (Cade, Ikuta-Mendoza, & Koonce, 2016). Some of the short-term obligations may include – but not limited to – loans that have short repayment periods, accrued expenses, and tax payable. The practice of classification must be adopted for substantive financial planning. It can also lay the groundwork for planning for the long-term liabilities. The method allows a firm to distribute assets evenly for use in business processes as clearance of short-term and long-term obligations. Some of the long-term obligations that a firm may clear include pension, leases, long term loans, and bonds.
References
Bova, E., Ruiz-Arranz, M., Toscani, F, & Ture, E. (2016). The Fiscal Costs of Contingent Liabilities: A New Dataset.
Cade, N., Ikuta-Mendoza, L., & Koonce, L. (2016). Assets and Liabilities: When do they exist?
Hussey, R., & Ong, A. (2017). Statement of Financial Position – Equity and Non-current Liabilities. doi:10.1057/978-1-137-52766-0_6.
Podolianchuk, O., Plakhtii, T., & Gudzenko, N. (2019). Current Liabilities and Their Accounting in the Attracted Capital Management System. Baltic Journal of Economic Studies, 5. doi:10.30525/2256-0742/2019-5-3-159-169.