Session 9
LIABILITIES
What are liabilities?
• A LIABILITY refers to an obligation of the business organization that is yet to be paid or settled.
• Such obligations arise from some past events or actions of the business organization.
The settlement of an obligation involves giving up something of value. Hence, liabilities can be settled through:
a) Cash payments/ payment through bank
b) Transferring goods or other assets or providing services in return
c) When an accounts payable/creditor (towards whom you have an obligation) waives off the obligation.
Types of Liabilities
Long term liabilities/
Non-current liabilities
Current liabilities/
Liabilities
Short term liabilities
Contingent liabilities
1. Non-Current Liabilities/ Long Term Liability
• Non-current liability of a business refers to obligations or debts that are not expected to be settled
within the next 1 year.
• Examples: Long-Term Loans and Borrowings, Deferred Tax Liabilities
Deferred Tax Liability:
• A deferred tax liability is an amount that a business needs to pay in taxes in the future due to temporary
differences between its accounting records and tax records/rules.
• In simple terms, a deferred tax liability represents taxes that the business will owe in the future because
it is reporting a lower taxable income/profit now compared to its accounting income.
Example: ABC College buys furniture for Rs. 1,20,000. For accounting purposes, it depreciates the furniture
over 12 years as per SLM, that is, charging Rs. 10,000 depreciation expense per year (assuming Rs. 0 as
salvage/disposal value).
However, for tax purposes, the Income Tax Act 1961 (of India) mandates that furniture should be depreciated at
10% per year using WDV. As per this, the deprecation expense for the first year should be Rs. 12,000 (10% of
Rs. 1,20,000), for the second year it should be Rs. 10,800 (10% of 1,08,000) and so on.
Now, for the first year, the depreciation charged in books of accounts (Rs. 10,000) is less than the depreciation
that should as per tax rules (Rs. 12,000). This higher amount of depreciation as per tax laws decreases the taxable
profit (because depreciation is an expense which reduces profit) this year, thereby lowering the amount of tax
paid in the first year. So, the business ends up paying lower tax (due to tax laws) vis-a-vis the tax as per the books
of accounts. This temporary difference in tax payment will eventually have to be paid by business to government
(liability) in the future periods, leading to the creation of deferred tax liability.
2. Current Liability
• A liability is classified as a current liability when it is expected or intended to be settled within 12
months or 1 year.
• Examples:
o Accounts payable/ Bills payable/ Trade payables/Creditors,
o Bank overdraft
o Expenses outstanding/due (money not yet paid for goods or services already received)
o Advances received (money received but goods or services are yet to be provided).
3. Contingent Liability
• A contingent liability is like a possible future debt or obligation that a business might have, but it's not
guaranteed to happen.
• It's a potential obligation that depends on certain events or conditions taking place in the future.
• In simple words, it's a "what if" situation where the business might need to pay or do something if
specific things happen.
• Example: Assume that XYZ enterprises is being sued by an employee, because the employee wants
compensation for some accident that happened at the workplace of XYZ (The employee is asking for a
compensation and fighting for it in the court). At this point, XYZ enterprises doesn't know if they will
have to pay anything or if the lawsuit will be successful. They might have to pay if the court decides in
favor of the employee. However, if the court rules in XYZ's favor, they might not have to pay much or
anything at all. This potential payment that depends on the lawsuit's outcome is a contingent liability.
So, a contingent liability is like having a possible bill that you might need to pay in the future, but it's uncertain
whether you'll actually have to pay it, depending on what happens later.
Important Note: In the books of accounts, contingent liabilities are not recorded as actual liabilities. Instead,
they are disclosed in the notes to the financial statements.
