In our ongoing series of accountancy FAQs we explain accounting jargon to help small business owners.
In this article we explain exactly what liabilities are, how they relate to assets and expenses, and the different types.
What is a liability?
In accounting, a liability is something which a business owes. These amounts are typically settled over time, or are recurring, rather than paid for upfront as you would with an expense.
Examples of liabilities include:
For a business, the idea of having liabilities, and therefore owing money, might be daunting. It’s actually not necessarily a bad thing.
Most businesses have liabilities and they are usually a result of necessary growth. For instance, buying new equipment on credit creates financial liabilities in the business, but also helps it grow.
However, too much liability can be a bad thing. It’s important that business owners keep track of what they owe to ensure their liabilities are manageable.
What is the difference between assets and liabilities?
In basic terms, assets are what’s in your pocket and liabilities are what comes out of it.
You owe liabilities, but own assets. Liabilities and assets are shown next to each other on the business’ balance sheet.
This important financial statement shows a snapshot of what the business owes, and what it owns. The difference between the two is called equity. It’s the value of the assets once the liabilities have been deducted.
What is the difference between an expense and a liability?
If a liability is money you owe, then why isn’t it just an expense? When a business incurs any sort of cost, it’s a liability until it’s paid.
For instance, your utility bills are an expense and a liability in the bookkeeping. When you pay for the bill, the bank balance reduces, and settling the liability.
What are the different types of liability?
When talking about liabilities, it’s also important to note that there are different types. These are current and non-current liabilities.
What are current liabilities?
Current liabilities are your business’ short-term obligations. This usually means money you owe within one year. For example, if you purchase materials from a supplier, you may not have to pay straight away but payment will still be expected soon.
What are non-current liabilities?
Non-current liabilities, also known as long-term liabilities, are obligations that aren’t due for a year.
Some examples of long-term liabilities include long-term loans, or mortgages. If you have taken out a business loan with a five-year repayment term, this will be classed a non-current liability.
How do I record liabilities in my bookkeeping?
If you purchase something but don’t pay straight away, when and how do you record it in your bookkeeping?
To record a liability, you will usually need to use the double entry bookkeeping method. This lets you record debit and credit entries.
An example of liabilities in bookkeeping
If you take out a loan, when you draw down the amount it increases the amount of money you have in the bank. This shows as an increase in your bank account, which is an asset. You would debit the asset account to show this.
Then, because it’s a loan which you must repay, you would record the loan as a credit to increase the balance of the liabilities account. Each instalment of loan repayment debits the liabilities account to show the liability on the loan decreasing.
And another example
If you receive an invoice from a supplier, it’s recorded as an entry in accounts payable. When you pay the bill, you debit accounts payable to decrease your liability balance.
Is there an easy way to record and track liabilities?
Sound complicated? If you’re new to business, then learning the lingo can be useful, but you don’t have to wade through the jargon by yourself.
A good accountant or bookkeeper will work with you to ensure your financial records are accurate.
You might also find that using accounting software (such as our very own Pandle!) makes the job even easier.
If you are looking for a new accountant who can help you record and track your liabilities, get in touch with The Accountancy Partnership. Get an instant quote for our online accounting services, or talk to one of the team on 020 3355 4047.
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About The Author
Forensics graduate-turned copywriter and blogger. I love turning complex topics into easy to understand, yet engaging pieces of content.