Nobody likes debt, but it’s often an inevitable part of a company keeping its doors open for business.
In this post, we’ll cover how businesses should account for liabilities. We’ll provide the two types of liabilities most businesses incur, along with three examples — and we’ll show you how a business should account for them.
The gamut of liabilities includes both short-term liabilities (less than a year) and long-term liabilities like bonds, mortgages and notes payable. Another type of liability can include loss contingencies, but we’ll leave that topic for another time.
At the basic level, liabilities are claims against the company by other business or its employees.
- Accounts payable: Money a company owes to its vendors for services and products it has purchased.
- Unearned revenues: Money received from clients that pay the business for goods and services they haven’t yet received — like deposits.
- Salaries payable: Wages the company owes to employees.
Generally accepted accounting principles (GAAP) dictate that when preparing the liability section of the balance sheet, any claims against the company have to be broken out between current and long-term obligations. The dividing line between the two is the one-year mark: All liabilities that are due within one year of the date of the financial statements are considered current. All others are considered long-term.
If a company anticipates paying a current liability with a long-term asset, or if it expects to refinance a current liability, that liability is treated as if it’s long-term.
Below is the fundamental accounting equation to consider when accounting for liabilities:
Assets = Liabilities + Owner’s equity
Based on the order of elements in this equation, liabilities show up on the balance sheet after total assets but before equity accounts. Current liabilities are shown first, followed by long-term liabilities.
Using the accrual method of accounting, all revenue must be matched with all expenses incurred during the production of that revenue.
So if a company incurs costs but money doesn’t change hands, a liability shows up on the balance sheet to reflect the amount that eventually has to be paid. For example, the company may make a purchase from a vendor without actually paying for it yet; that item appears in accounts payable, which is a current liability.
For more information on how your business should account for its liabilities, contact the Onisko & Scholz team today.
Or give us a call at 562-420-3100 and one of our tax experts will be happy to help you.