Classification Of 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.
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.
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
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 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:
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:
capital as on 1-1-2011
2011 – profit
Owner’s capital as on 31-12-2011
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.