Liabilities: accounting yourself accountable

In the world of business, many companies will accept payments before providing service or delivery. Likewise, some may accept a good or service before they submit a payment. In both of these cases, the party acquiring unfulfilled obligations would partake in the recording of what is known as a LIABILITY.

A liability is basically obligations held by a company. It can also be referred to as a creditor's claim on an asset; a source of the company's assets; or even a creditor's claim against the assets currently held by the company. Nonetheless, a company must record each liability acquired within an accounting period as it directly affects the balance sheet at any point in time. It is relevant now to refer to the accounting equation:

Assets = Liabilities + Equity     ---------->     Liabilities = Equity - Assets

Note that an increase in liabilities yields an increase in assets as is reflected in the balance sheet.

Liabilities have a normal credit balance, thus are decreased when recorded as a debit. There are many different forms of liabilities, but many can be spotted by two key words: "UNEARNED" and "PAYABLE". Other common liability accounts include, but are not limited to, the following:

Notes Payable
Accounts  ""
Wages  ""
Salaries  ""                    
Notes  ""
Interest  ""
Unearned Revenue
Fees Unearned

It is pretty easy to spot a liability on a balance sheet, and this is to the benefit of all entities involved in a particular transaction. The sooner one party fulfills its obligations/liabilities to another, the sooner both can resume normal business practices.

As liabilities are accrued, they are recorded as a credit. Inversely, as they are fulfilled, they are reduced by being recorded as a debit. An example of this is provided:



Assume that on May 4, Company X buys a TV at a cost of $500 on credit from Tele Co. Company X would record the transaction in the journal as follows:

May 4           Television                                                 500
                                 Accounts Payable - Tele Co                  500

Now assume that on June 1, Company X pays the $500 in cash to Tele Co. (and that Tele made this sale in on Craigslist where no sales tax or interest rates applied). Company X would record the transaction as follows:

June 1           Accounts Payable - Tele Co.                    500
                                  Cash                                                      500

The ledger for the ACCOUNTS PAYABLE account would appear as follows:

Accounts Payable         In this case, since the account payable is completely fulfilled, the balance
   500     |    500              in the account as of June 1 is $0.
              |     0


On the flip side, a company can receive payment before providing service. This case is presented below:


Assume that on Jan. 1, Company X receives $500 cash for a tutoring service that is to take place over the next 5 months ($100/month) and is to start immediately. Company X would prepare this journal entry on Jan. 1:

Jan. 1        Cash                                                 500
                         Unearned Tutoring Fees                  500

On March 1, Company X has provided 2 months of service (worth $200) and will record the following journal entry:

March 1          Unearned Tutoring Fees             200                             Note that revenue is recorded
                                   Tutoring Revenue                    200                      when earned!!!


As a result of this entry, the company can recognize that 2 months' worth of tutoring revenue has been earned. Also, by analyzing an u[dated ledger, it will assure that 3 more months of service must be provided in order to earn the full revenue of $500.


A final note, business would not exist without liabilities... think about that this week.







Another final note...63 days till Christmas!