Account Types: Liabilities

Question 1

What 3 broad categories can Liabilities be broken down into?

Answer 1

•Current Liabilities
•Non-Current Liabilities
•Contingent Liabilities

Question 2

Are Liabilities a bad thing?

Answer 2

The word liabilities makes them sound like a bad thing, like we want to avoid them.

But this isn’t the case.

Liabilities are just a normal part of business and are nothing to be afraid of.

Question 3

Are Liabilities a bad thing?

Answer 3

The word liabilities makes them sound like a bad thing, like we want to avoid them.

But this isn’t the case.

Liabilities are just a normal part of business and are nothing to be afraid of.

Question 4

What are Liabilities?

Answer 4

Liabilities are probable future sacrifices of economic benefit arising from present obligations of a partial entity to transfer assets or provide services other to entities in the future as a result of a past transactions or events.

Question 5

When defining Liabilities, what does the term “probable” mean?

Answer 5

Probable hints at uncertainty. When dealing with liabilities, accountants often have to use their own judgement of situations to estimate future outcomes.

This is especially the case when it comes to Accruals.

Question 6

In Liabilities, what does “ future sacrifices” mean?

Answer 6

Future sacrifices means we are going to have to give something up in the future.

Question 7

Define Economic Benefit as it relates to Liabilities.

Answer 7

Economic Benefits relates to the things that have value. More specifically assets and services, and that doesn’t only mean cash.

Question 8

The definition of liabilities states that liabilities are present obligations resulting from past transactions or events.

So what must happen before you can recognize a liability?

Answer 8

In order to recognize a liability, the transaction or event that committed us to transferring assets, or providing services, must have happened already.

Question 9

Why is it important to understand what liabilities are?

Answer 9

Because liabilities are a crucial part of normal business.

Question 10

What is a simpler way to think of Liabilities?

Answer 10

A simpler way to think of liabilities is that they are a source of third party funding that a business uses to buy assets and fund operations.

Question 11

Businesses have two broad financing options when it comes to buying assets. What are they?

Answer 11

If we bring the accounting equation back up.

Assets = Liabilities + Equity

We can see that broad financing option 1 is Liabilities which are for third parties and broad financing option 2 is Equity, which is money invested into the business from its owners.

Question 12

How do you go to get a summary of a businesses liabilities?

Answer 12

You look at the companies balance sheet.

Remember, the balance sheet is a snapshot of a business assets, liabilities and equity at a single point in time.

Question 13

What does the liability section of the balance sheet look like?

Answer 13

In the liabilities section of the balance sheet we list out all of our different liabilities.

Typically these categories are arranged in order of their due date with the short-term liabilities and the longer-term liabilities further down.

Question 14

Short-term Liabilities are Current Liabilities.

What is a Current Liability?

Answer 14

Current Liabilities are a businesses obligations that need to be settled within 1 year.

The most common type of Current Liability is Accounts Payable.

Question 15

Define Accounts Payable.

Answer 15

Accounts payable relate to the bills or invoices we get sent when buying something from a supplier on credit.

Question 16

Why would businesses want to buy something on credit?

What does credit mean?

Answer 16

Buying something in credit means you’re agreeing to pay later.

Or if your head works like an accountant, you are making a present obligation to transfer assets or provide services to another entity in the future.

Question 17

In a standard business transaction we have two parties. Buyer and seller.

The seller provides the buyer with a product or service along with an invoice or bill.

In return the buyer sends them cash to settle the payment. However, what if a seller offers them a credit?

Answer 17

Sellers sometimes like to incentivize buyers to spend more money and bring the purchases forward by offering them credit to terms.

Question 18

We have an example of a business owner who needs carrots, but is low on cash and really needs to make a certain dish.

The owner calls the local food wholesaler who offers him credit with 30 days to pay.

What happen in an accounting point of view on the buyer and seller sides of the transaction?

Answer 18

When the buyer receives the invoice from the supplier, they recognize an account payable balance for the amount owed.

On the other side of the transaction, the seller recognized an equal and opposite accounts receivable balance for the same amount.

Question 19

What would the buyer and seller transaction look like as journal entries?

Answer 19

Buyer Seller

DR Carrots X DR A/R X
CR A/P (X) CR REVENUE (X)

Question 20

Define Salaries Payable.

Answer 20

Salaries Payable is a Current Liability.

If a business employs staff they need to pay them. They are paid out depending on the company, but often times at the end of the month.

So when you prepare your books at the end of the month, you need to recognize a balance for salaries payable.

Question 21

Businesses have to pay tax on the profits they generate. So what do they need to recognize?

Answer 21

Taxes Payable. Which go on their balance sheet.

Interest Payable. If you take notice, most current liabilities include the word”payable” in them, which makes them easy to identify as liabilities- But that’s not ALWAYS the case.

Question 22

What are Accruals or Accrued Expenses?

Answer 22

Accrued Expenses are adjusting journal entries that are typically posted by accountants at the end of the month to recognize expenses that have been incurred, but have not been recognized yet in the books.

Question 23

The restaurant owner calls his accountant at end of the month to update his books in order to see their performance for this month.

The accountant asks if the company had any Accruals to account for?

The owner states they had a plumber in to fix a dishwasher, and he didn’t think they sent an invoice yet.

The accountant asks what the other company quoted to to complete the job and he stated he didn’t give a quote, but a similar job last time was $500.

How do we account for this situation?

Answer 23

In this situation, the restaurant incurred an expense in its current month because the Plumber has provided them with the service.

However, they have not received an invoice, so the liability and the expense haven’t been recorded in the books yet.

So his accountant posts an accrual in the books to recognize an accrued expense of $500.

DR Expenses $500 DR AccruedRevenue X
CR Accruals ($500) CR Revenue. (X)

Question 24

The restaurant’s repair company has done similar jobs to the current one for $500 and the accountant uses this as a cost estimate.

Why is this an estimate for accounting purposes?

Answer 24

This is an estimate because there is no supporting invoice to match the transaction.

However, by recording the transaction, his accountant is ensuring the business’s income statement and balance sheet will give an accurate picture of the restaurants financial performance.

Accruals are probably worthy of much more research.

These are Current Liabilities.

Question 25

What is Unearned Revenue?

Answer 25

You can think of Unearned Revenue as the opposite of a prepayment.

They come up when someone pays you for a good or service in advance.

This might sound like an asset, and you are right- cash is an asset, but we are double entry book keeping, so there is another side to the transaction.

In this case, it’s Unearned Revenue which is the liability because you have the obligation to transfer assets or provide a service in the future.

Question 26

What are Short-term Loans?

Answer 26

Short- Term Loans are loans that need to be settled within 1 year.

But Short-term Loans can also refer to the current portion of long term loans, which are Non-Current Liabilities.

Question 27

What are Non-Current Liabilities?

Answer 27

Obligations that are not expected to be settled within 1 year.