What is a passive?
The word “liability” can have different meanings in law, insurance, politics and finance. In finance and accounting, a liability is a debt owed by a person or entity. Financial liabilities can also represent legal obligations to pay money in the future, such as a lease.
Liabilities are key accounting items that are included on a company’s balance sheet and figure prominently in determining a company’s net worth, book value, or equity, which are essentially all the same . For this reason, liabilities are important to investors and there are accepted rules in the business world regarding what constitutes a liability and how they should be measured in financial statements.
Passives vs Assets
Simply put, assets are what a business (or individual) owns and liabilities are what they owe.
Liabilities are debts due or financial obligations. People have liabilities, as do most investment entities such as funds, partnerships, and corporations. For public companies, liabilities represent a key balance sheet item that is subtracted from a company’s assets to determine its net worth to investors.
Assets are anything of value that a business owns. This could include real estate, equipment, product inventory, vehicles, raw materials, and even intellectual property like patents and copyrights.
When determining the value of a company – an important measure for shareholders – the values of all assets are added together. Then, according to the formula
Net worth = Active passive
any debts or other liabilities of the business are subtracted from the total value of assets to determine net worth. In concept, a company’s net worth is the amount that would remain if the company liquidated all of its assets and paid off all of its debts. Also referred to as equity.
Liabilities therefore represent an offset to assets on a company’s books and can be considered ‘negative assets’ as they would need to be repaid to arrive at an accurate equity figure. If a person or business has $10,000 (equity) to spend on a car, they can buy a $30,000 car by borrowing the remaining $20,000 as a car loan. After the purchase, the net worth (or equity) – which is the value of the assets ($30,000) minus the liabilities ($20,000) – remains at $10,000.
Types of liabilities
Liabilities are classified either as running Where long term and identified separately on most balance sheets before being added together as total liabilities.
Short-term liabilities are those that can reasonably be expected to be repaid within a year, and long-term liabilities are those that would take longer than a year.
Types of current liabilities
Current liabilities generally include:
- accounts payable,
- taxes and salaries, which are usually due within the next twelve months.
- debt that matures within the next 12 months.
Types of long-term liabilities
Long-term liabilities generally include:
- long-term bonds issued by the company,
- pension obligations to current and past employees
- movable or immovable leases for a period of more than one year.
Liability versus expense
Expenses represent monetary obligations that have already been paid. Expenses would appear on an income statement rather than a balance sheet since they are neither an asset nor a liability for the business. Expenses include utility expenses, interest paid, purchases of supplies or materials, or payments for services such as maintenance or deliveries.
In contrast, liabilities represent money that is committed but not yet paid and is still due or committed. This includes rental payments, unpaid wages, and payments due for materials received or services rendered. Once liabilities are paid, they become expenses and are no longer included in a balance sheet.
Examples of Liability
Here are some examples of business liabilities:
- Outstanding loans
- Payment plans on purchased equipment
- Payments due to suppliers
- Payments due for products purchased or services obtained
- Salaries payable (workers’ compensation not yet paid)
- Customer deposits
- Taxes due
- Interest due on outstanding bonds or preferred shares
- Unpaid fines or legal obligations
- Unpaid pension contributions
What is a contingent liability?
A contingent liability is a potential liability that may arise in the future. Companies may face potential future liabilities if they are in litigation or have issued product or service warranties that will need to be honored in the future. Contingent liabilities are not included in a balance sheet, but when such liabilities are deemed likely to occur and can reasonably be estimated, companies are expected to mention them in financial reports.