Liabilities are obligations the company has to provide goods, services, or payment to third parties.
Liabilities appear on the balance sheet under the ‘liabilities and equity’ section. Liabilities are recorded at the amounts at which the liabilities are expected to be settled. Often, these settlement amounts must be estimated.
Liabilities are classified as current or long-term. Current liabilities are those obligations which are expected to be settled within the greater of one year or the firm’s operating cycle. Long-term liabilities are those obligations which are expected to be settled at a date later than the greater of one year or the firm’s operating cycle.
Liabilities may also be classified as operating liabilities or financial liabilities. Operating liabilities are liabilities which arise out of the firm’s operating transactions. Operating liabilities may correspond with expenses or assets. For example, a homebuilder will establish a warranty reserve in the period in which a new home is delivered to the customer. The warranty reserve is a liability which corresponds to the warranty expense recognized in the same period. Another example of an operating liability is accounts payable. Accounts payable usually correspond to inventory but may also correspond to operating expenses.
Financial liabilities are borrowed funds which a company uses to finance its business. Some loans are short-term and are thus classified as current liabilities. For amortized loans – i.e., loans which are periodically paid down – a company must separate the amount due within a year (or operating cycle, if greater) from the amount due beyond one year. The amount of a long-term loan due within one year is classified as a current liability.