Classification Of Liabilities

Current Liabilities:

When the liabilities of a business enterprise are due within an accounting period or the operating cycle of the business, they are classified as current liabilities. Most of the current liabilities are incurred in the acquisition of materials or services forming part of the current assets. These liabilities are expected to be satisfied either by the use of current assets or by the creation of other current liabilities. The one year time interval or current operating cycle criterion applies to classifying current liabilities also. Current liabilities generally consists of bills payable, creditors, outstanding expenses, income received in advance, provision for income-tax etc.

Accounts Payable:

These amounts represent the claims of suppliers related to goods supplied or services rendered by them to the business enterprise for which they have not yet been paid. Usually these claims are unsecured and are not evidenced by any formal written acceptance or promise to pay. When the enterprise gives a written promise to pay money to a creditor for the purchase of goods or services used in the business or the money borrowed, then the written promise is called as bills payable or notes payable. Amounts due to financial institutions which are suppliers of funds, rather than of goods or services are termed as short-term loans or by some other name that describes the nature of the debt instrument, rather than accounts payable.

Outstanding Expenses:

These are expenses or obligations incurred in the previous accounting period but the payment for which will be made in the next accounting period. A typical example is wages or rent for the last month of the accounting period remaining unpaid. It is usually paid in the first month of the next accounting period and hence it is an outstanding expense.

Income Received In Advance:

These amounts relate to the next accounting period but received in the previous accounting period. This item of liability is frequently found in the balance sheet of enterprises dealing in the publication of newspapers and magazines.

Provision For Taxes:

This is the amount owed by the business enterprise to the government for taxes. It is shown separately from other current liabilities both because of the size and because the amount owed may not be known exactly as on the date of balance sheet. The only thing known is the existence of liability and not the amount.

Long Term Liabilities:

All liabilities which do not become due for payment in one year and which do not require current assets for their payment are classified as long-term liabilities or fixed liabilities. Long term liabilities may be classified as secured loans or unsecured loans. When the long-term loans are obtained against the security of fixed assets owned by the enterprise, they are called as secured or mortgaged loans. When any asset is not attached to these loans they are called as unsecured loans. Usually long-term liabilities include debentures and bonds, borrowings from financial institutions and banks, public debts, etc. Interest accrued on a particular secured long term loan, should be shown under the appropriate sub-heading.

Contingent Liabilities:

Contingent liabilities are those liabilities which may or may not result in liability. They become liabilities only on the happening of a certain event. Until then both the amount and the liability are uncertain. If the event happens there is a liability; otherwise there is no liability at all. A very good example for contingent liability is a legal suit pending against the business enterprise for compensation. If the case is decided against the enterprise the liability arises and in the case of favourable decision there is no liability at all. Contingent liabilities are not taken into account for the purpose of totaling of balance sheet.

Capital Or Owners’ Equity:

As mentioned earlier, owners’ equity is the residual interest in the assets of the enterprise. Therefore the owners’ equity section of the balance sheet shows the amount the owners have invested in the entity. However, the terminology `owners’ equity, varies with different forms of organisations depending upon whether the enterprise is a joint stock company or sole proprietorship / partnership concern.

Sole Proprietorship / Partnership Concern:

The ownership equity in a sole

Proprietorship or partnership is usually reported in the balance sheet as a single amount for each owner rather than distinction between the owners initial investment and the accumulated earnings retained in the business. For e.g. In a sole-proprietor’s balance sheet for the year 2011, the capital account of the owner may appear as follows:

Joint Stock Companies:

In the case of joint stock companies, according to the legal requirements, owners’ equity is divided into two main categories. The first category called share capital or contributed capital is the amount the owners have invested directly in the business. The second category of owners’ equity is called retained earnings.

Share capital is the capital stock pre-determined by the company by the time of registration. It may consist of ordinary share capital or preference share capital or both. The capital stock is divided into units called as shares and that is why the capital is called as share capital. The entire predetermined share capital called as authorised capital need not be raised at a time. That portion of authorised capital which has been issued for subscription as on a date is referred to as issued capital.

Retained earnings is the difference between the total earning to date and the amount of dividends paid out to the shareholders to date. That is, the difference represents that part of the total earnings that have been retained for use in the business. It may be noted that the amount of retained earnings on a given date is the accumulated amount that has been retained in the business from the beginning of the company’s existence up to that date. The owners’ equity increases through retained earnings and decreases when retained earnings are paid out in the form of dividends.