The Conceptual Framework for Financial Reporting defines a liability as ‘a present obligation arising from past transactions or events, the settlement of which is expected to result in an outflow of economic benefits from the entity’. In simple terms, a liability is something that a company owes and when the company come to pay off the liability money, will be taken out of the company to settle this. It’s important to understand the effects liabilities have in accounting, which is covered in our AAT Level 2 accounting qualification.
Current and non-current liabilities in accounting
Liabilities are then split between current liabilities and non-current liabilities. Current liabilities are those which are to be settled within 12 months. This includes:
- Trade creditors
- Bank overdraft
- VAT creditor
- Short term loan
Non-current liabilities are then those which will be settled after 12 months, for example bank loans, leases and mortgages. Both will appear on the Statement of Financial Position. Current liabilities will often be shown as a minus figure against current assets to arrive at the net current assets. Non-current liabilities are often just shown under their own heading.
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How liabilities are recorded
A liability is recorded in the financial statements as a credit balance. For example, a company has taken out a bank loan for £100,000 over 25 years. It would be recorded by debiting the bank account (where the loan has been paid into) and then crediting the bank loan account. Each time a repayment is made against the loan the balance would reduce and would need to be recorded with a debit to the liability account and a corresponding credit entry to the bank account. Any interest charges would increase the liability, so would need to be recorded by crediting the bank loan account and a corresponding debit entry into the interest expense account.