What are liabilities in accounting? A Complete Guide

In accounting, liabilities correspond to the right-hand column of the balance sheet. This term refers to all the financial and material resources available to a company. These resources were created when the company in question was founded to form its assets.

These resources are used to finance activities related to operations. Concretely, liabilities in accounting represent all the debts that the company may have contracted with various economic actors, whether commercial companies, banking establishments, public institutions or individuals.

What is a liability in accounting?

Liabilities are a widely used term in accounting. They refer to the negative values included in the company’s assets, shown on the balance sheet. They include not only all debts, but also equity and provisions for risks and expenses.

In other words, liabilities in accounting are made up of:

Loans and other debts contracted with a person (natural or legal) outside the company;
Investments (contributions of all kinds) from partners.

The resources thus constituted allow the company to begin carrying out the activities for which it was created. They also provide the possibility of ensuring its operation and financing its development.

Even if these debts have allowed the company to launch its business, it is in the company’s interest to ensure that their amount remains reasonable. Indeed, if they are too high, they risk becoming an obstacle to its long-term development. In this situation, the entrepreneur may struggle to repay the installments if the number of its sales decreases. It will not even be possible to take out other loans to take advantage of opportunities that may arise.

Definition

Liabilities are an accounting term used to describe all items that have a negative economic value and constitute part of a company’s assets. Having been acquired from various economic stakeholders, they generate obligations towards them. These obligations will result in an outflow of the company’s resources to their benefit.

In other words, liabilities are a heterogeneous set of debts, obtained from third parties to enable it to finance its assets. However, in return for these funds, the company will have to concede to an outflow of resources. It is the element placed parallel to the assets and which forms with the latter the accounting balance sheet of the company.

Challenges

Assets and liabilities are two closely related elements. The former refers to the set of all the goods and rights that a company has. Corresponding to an inflow of resources, it has a positive economic value. As for the latter, it is a set of debts, which can be considered its exact opposite.

However, liabilities are the original source of financing. Given the elements that compose them, detailing them provides a means of determining precisely what the company owes. This information allows you to know the amount of debts. It makes it possible to prepare a strategy to repay the loans on their due dates and to define development actions.

It should be noted that the balance sheet follows accounting rules. Any financial movement recorded there must be recorded in duplicate. One is used to identify the source of the money, the other to find out its destination or use. In other words, these flows must be indicated in both the assets and liabilities. Therefore, they must total the same amount.

What are liabilities made up of in accounting?

The right-hand column of the balance sheet, reserved for liabilities in accounting, is generally used to explain the origin of all financial resources available to the company. This section provides an overview of the debts recorded at the time the accounting entries are closed. This column is divided into two parts, namely:

Top of the balance sheet ;
Bottom of the balance sheet.

The values are placed in the table in a specific order. At the very top are the long-term resources available, starting with the partners’ contributions injected into the share capital.

The most stable funds at the top of the balance sheet will give way to short-term debts, lasting a few days or weeks. Liabilities also include operating profits, as well as various debts and expenses for the benefit of:

Suppliers;
Banking establishments;
Public institutions (such as the tax administration).

Equity

Equity consists of stable resources derived from the partners’ long-term investments. Their classification as liabilities is explained by the fact that they constitute a debt owed to them. According to legal provisions, this category may include regulated provisions, such as exceptional depreciation.

In the balance sheet, equity is generally included in a subtotal under liabilities. It can also be included in the “other equity” section, along with proceeds from the issuance of participating securities and conditional advances. However, these accounts are only used anecdotally.

Net result

Net income is the result of operations. In concrete terms, it corresponds to the difference between the income obtained and the expenses related to the accounting period. Its inclusion in liabilities allows for a balanced balance sheet. In fact, thanks to it, the total amount of liabilities corresponds perfectly to that of assets.

Please note: depending on the operating situation, net income may be a profit or a loss. However, in either case, it will always be included in liabilities, ensuring a balance between assets and liabilities. Furthermore, it is considered a debt owed by the company to its partners.

Company reserve

The entrepreneur may decide not to distribute a significant portion of the profits from his business to his partners. The money thus collected forms the company’s reserve. It provides the company with a fund to finance the development of its activities.

These reserves can take three different forms:

Legal reserves;
Regulated reserves;
Statutory or contractual reserves.

Share capital

When creating a business, those who wish to become partners must make contributions. The assets thus constitute the share capital. This is the first element of its assets. It is classified as a liability, as it can be returned to its original owner or to his heirs when the business comes to an end.

Debts

Debts correspond to certain accounts in classes 1 and 4. They are essential to the operation and development of the company, as they allow it to have the necessary resources.

A company cannot operate without owing more or less substantial sums of money to its various partners. These debts, whether operating-related or financial in nature, must appear on a portion of the balance sheet.

In the liabilities column, a distinction is made between debts according to their due dates, ranging from long-term to the most urgent. Four types of debts are linked to the operation of the company, namely:

Supplier debts;
Social debts;
Tax debts;
Debts on fixed assets.

Social and tax debts

In its social dimension, the company must pay its debts. They are made up of two elements, namely the sum of money to be paid:

Occasionally to French social security such as monthly social contributions;
To staff, including remuneration.

Tax debts, on the other hand, include all the sums of money that the company must pay to the state through the tax authorities. These are the various taxes that the company owes.

Supplier debts

A company that wants to optimize its operations must establish trusting relationships with its suppliers. This allows it to obtain goods, raw materials, and services of various kinds, provided it reimburses them on time.

Debts on fixed assets

As their name indicates, these are the debts that the company has contracted with certain suppliers and which allow it to dispose of fixed assets. The company must also ensure that they are paid at the time agreed with its creditors.

Provisions for risks and charges

In most cases, accounting data concerns cash movements that have already occurred. Regarding provisions for risks and expenses, they concern future events, i.e., events occurring prior to the end of the financial year. This advance accounting focuses on events that could potentially generate debts for the company, without the exact amount being known in advance.

However, this anticipation will only appear in the balance sheet if two conditions are met. Indeed, the amounts of future debts can be estimated as reliably and accurately as possible. It is also necessary that the facts have a high probability of occurring.

Provisions for risks and charges are placed just below equity. A typical example to illustrate this case is the dismissal lawsuit. If this is underway, the company can already prepare for the eventuality that it loses the case, especially regarding the compensation to be paid, even if it has no way of knowing in advance their exact amount. However, it can refer to the legislation in force and find out about similar cases to make a realistic estimate.

Provisions for charges

Provisions for charges refer to all the provisions that the company has clearly established when closing the balance sheet. Indeed, it has the obligation to ensure that its annual accounts for these provisions are as faithful as possible at the time of preparing the document.

Please note: provisions for charges may relate, for example, to work which must be carried out during the following financial year.

Provisions for risks

Risk provisions concern the consideration of default risks. They allow preparation for encountering doubtful customers who may avoid their obligations.

Once forecasted and estimated, this information must be recorded as a liability on the balance sheet. However, the company must exercise the utmost caution with its business partners to avoid incurring excessive financial losses.

What is transitional liability?

In the balance sheet, a place is given to the transitional liability. This account allows the recording of income received in advance and expenses that must be paid . This transitional liability can be used between two different financial years.

What about the book asset?

The asset term of the balance sheet is used to designate all the elements, whether tangible or intangible, that the company owns. It constitutes the part of the document that has a positive value for the company concerned. In other words, it is the set of identifiable elements of its assets that it can use as it sees fit for the needs of its activities.

Like liabilities, it is subject to a thoughtful classification, ranging from the least liquid components, i.e. fixed assets, to the most liquid components, including cash. It is distinguished by the fact that its components are made to generate resources, whether in the present or in the future.

The book asset is placed on the left side of the balance sheet. It can be divided into two parts, namely:

Regarding the latter, it is the part of the asset which groups together all the goods which can be used sustainably for the needs of the operation. It is divided into three categories, namely:

Intangible assets including all assets without physical and non-monetary substances (business assets, patents, lease rights or establishment costs);
Tangible fixed assets grouping together physical assets (buildings, machinery, movable property, etc.);
Financial fixed assets concerning all durable financial assets.

Unlike fixed assets, current assets refer to all assets that will not be used on a long-term basis. It should be noted that they are intended to be monetized in the short term.

Furthermore, current assets include 6 headings, namely:

Stocks and work in progress;
Advances and deposits;
Receivables;
Investment securities;
Availability;
Prepaid expenses.

Example of the liabilities part of the balance sheet

This table allows you to see the items found in the liabilities section of the balance sheet. As mentioned previously, it contains in particular:

Equity;
Provisions for risks and charges;
Debts.

Balance Sheet – Liabilities (PASSIVE)

(Values in thousands, currency units assumed)

Category	Item	Exercise N	Exercise N-1
EQUITY	Capital [of which paid]	500	500
	Issue, merger and contribution premiums	120	100
	Revaluation difference	20	20
	Equivalence gap	10	15
Reserves	Legal reserve	50	45
	Statutory or contractual reserves	30	30
	Regulated reserves	25	20
	Other reserves	10	12
	Carry forward	40	35
	Result of the financial year [profit or loss]	75	60
	Investment grants	5	5
	Regulated provisions	15	10
Total I – Equity		950	887
PROVISIONS FOR RISKS AND CHARGES	Provisions for risks	35	40
	Provisions for charges	20	25
Total II – Provisions		55	65
DEBT	Convertible bonds	0	0
	Other bond issues	200	150
	Loans and debts from credit institutions	300	280
	Loans and various financial debts	100	90
	Advances and deposits received on current orders	15	10
	Supplier debts and related accounts	120	140
	Tax and social security debts	90	85
	Debts on fixed assets and related accounts	25	20
	Other debts	50	45
	Treasury instruments	60	60
	Deferred income	30	28
Total III – Debt		990	908
OTHER	Liability translation differences (IV)	10	12
GRAND TOTAL (I + II + III + IV)		2,005	1,872

FAQs

What is the purpose of the balance sheet?

Preparing a balance sheet is an annual routine for most businesses. This exercise allows them to highlight the various elements that contribute to generating financial gains and the elements that mobilize them. The balance sheet is essential for understanding the state of financial health.

What is a passive translation difference?

In accounting, a translation adjustment liability is a term that refers to the unrealized gain or loss that arises on a foreign currency debt. This item should be considered for all unmatured debts. Therefore, it is important to ensure that this unrealized gain or loss is accrued.

What are the balance sheets of the company?

The balance sheet includes three elements, namely working capital (a variable highlighting the company’s financing policy), working capital requirements (amount needed to finance current expenses before receipts) and cash requirements (difference between working capital and working capital requirement).