Liabilities

Liabilities represent an obligation to provide resources at some point in the future. These obligations can entail a wide variety of items, including amounts owed to suppliers, amounts due to employees for compensation earned, withholdings from employees’ wages and salaries, various amounts owed to other third parties, debts from borrowings, deferred income taxes, and a number of complex financing arrangements. The Financial Accounting Standards Board (FASB) has defined liabilities as “probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” The FASB also commented that all liabilities appearing on the balance sheet should have three characteristics in common: (a) They should be present obligations that entail settlements by probable future transfers or uses of cash, goods, or services; (b) they should be unavoidable obligations; and (c) the transaction or event obligating the enterprise must have already happened.

Current liabilities are obligations that must be satisfied within one year. They are expected to require the use of current resources or the creation of other current liabilities. Current liabilities can include a variety of items including accounts payable, short-term debts (due within one year from the balance sheet date), current maturities of long-term debts, dividends payable to stockholders, deferred revenues (services yet to be performed that are expected to require the use of current resources), and various accruals for items such as wages and salaries.

Liabilities can be specified by formal contract or by informal agreements, but they generally involve future cash outflows. Present value methods may be used to value certain liabilities on the balance sheet. In the case of current liabilities, however, the time period between present value and the time that the actual cash payment is due or the face value is normally immaterial; therefore, most current liabilities are recorded at their face value. Other long-term liabilities that do not bear interest may be discounted at an appropriate interest rate.

Long-term liabilities are obligations that will be due at some point beyond one year from the balance sheet date. These long-term obligations typically include notes payable, bonds payable, and capital lease obligations. Long-term liabilities are normally supported by written formal agreements. These formal agreements underlying such agreements typically specify the principal amount of the obligation, the periodic interest payments, the time over which the interest and principal are to be paid, collateral provisions, and, if applicable, covenants to protect the interests of the lender.

Long-term liabilities often arise from a company financing the purchase of real property and/or operating equipment for the business. When a company executes a formal agreement with a financing institution to borrow funds, in most instances the lender will provide an amortization schedule that will indicate the amount of principal and interest due for each period until the maturity date of the agreement. The amortization schedule enables the company to evaluate their ability to service the debt as it comes due. The portion of principal payment due in one year or less should be classified as a current liability on the company' balance sheet, as discussed earlier. The portion of principal that will be due over the remaining term of the agreement should be classified as long-term debt on the company' balance sheet. Certain types of bonded indebtedness may require a company to periodically set aside funds into a reserve or sinking fund account. These sinking funds will be used to service the debt as it comes due and are intended to provide the lender with a higher degree of confidence that the company will be able to meet the debt service requirements as they come due.

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