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Mortgage Dictionary -> Liabilities

Defining Liabilities

As a financial concept, the word liabilities is often used interchangeably with the word debts. Specifically, liabilities are obligations resulting from transactions that occurred in the past. The settlement of liabilities may require a future transfer of assets, services, or other economic benefits. Liabilities are most often legally enforceable contractual obligations, but may also be equitable or constructive obligations. Equitable obligations are liabilities based on ethical or moral considerations, while constructive obligations are liabilities that derive from established patterns of practice or published policies which indicate a willingness to accept liability.

The basic accounting equation, which is both the basis for the double-entry bookkeeping system and the structure of the balance sheet, shows the relationship between assets, liabilities, and owner equity:

Assets=Liabilities + Owner Equity

Within the balance sheet, liabilities are generally divided into two categories, current liabilities and long-term liabilities. Current liabilities are short-term debts that will be settled within the current fiscal year or operating cycle, whichever is longer. These obligations include examples such as employee wages, taxes, and accounts payable. Current liabilities are generally expected to be settled using the company's current assets. Long-term liabilities are the liabilities which fall outside of the fiscal year or operating cycle, and their settlement is expected to be made from the company's non-current, or long-term, assets. Examples of long-term liabilities include: long-term leases, pension obligations, and bank notes of longer than one fiscal year. If a company possesses a liability that cannot be classified as either a current liability or a long-term liability, then the liability can be referred to as a "provision." Provision is a temporary title in accounting that denotes a liability for which the timing, the amount, or both are unknown.

Liabilities which have occurred but have not yet been payed or logged under accounts payable are referred to as accrued liabilities. Accrued liabilities occur when goods or services have been contracted, but have not yet been correctly invoiced or recorded. When determining the financial solvency of a business, it is important to consider the accrued liabilities in addition to any current and long-term liabilities which have already been added to the general ledger.