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What are liabilities in bookkeeping?
In Bookkeeping Services in Knoxville, a liability is a legal financial obligation that a business owes to an external party. While assets represent what a business owns, liabilities represent what it owes.
Every time a business borrows money, buys supplies on credit, or receives a service it hasn't paid for yet, it must record a liability in its books.
1. How Liabilities are Classified
Bookkeepers categorize liabilities based on when they must be paid. This helps the business understand its "liquidity"—essentially, how much cash it needs to have ready in the near future.
Current Liabilities (Short-term)
These are debts expected to be settled within one year or within the business's normal operating cycle.
Accounts Payable: Money owed to suppliers for inventory or office supplies purchased on credit.
Accrued Expenses: Costs that have been incurred but not yet invoiced or paid (e.g., electricity used this month but billed next month).
Wages/Salaries Payable: Money earned by employees that has not yet been distributed via a paycheck.
Unearned Revenue: Money received from a customer for a service you haven't performed yet (you "owe" them the work).
Non-Current Liabilities (Long-term)
These are obligations that will take more than one year to pay off.
Notes Payable: Formal written promises to pay a specific amount of money, often with interest (like a 3-year bank loan).
Mortgages Payable: Long-term loans used to purchase business real estate.
Deferred Tax Liabilities: Taxes that are calculated now but will be paid in a future year.
2. Liabilities in the Bookkeeping Ledger
In a double-entry bookkeeping system, liabilities follow specific rules for recording transactions.
The "Credit" Rule
Unlike assets, which have a natural debit balance, liability accounts have a natural credit balance. This means:
To increase a liability (e.g., taking out a loan), you Credit the account.
To decrease a liability (e.g., paying off a bill), you Debit the account.
Example: You buy $500 worth of office paper on credit.
Debit Office Supplies (Asset increases).
Credit Accounts Payable (Liability increases). When you pay the bill 30 days later:
Debit Accounts Payable (Liability decreases).
Credit Cash (Asset decreases).
3. Liability vs. Expense
A common point of confusion for beginners is the difference between a liability and an expense.
An Expense is the cost of doing business during a specific period (e.g., "Advertising Expense").
A Liability is the obligation to pay for that cost if it wasn't paid immediately in cash.
If you pay for advertising with cash immediately, it is an expense but never becomes a liability. If you put that advertising on a credit card, it is an expense and a liability until the credit card is paid off.
4. Why Bookkeepers Track Liabilities
Tracking liabilities isn't just about knowing what you owe; it’s about financial health:
Solvency: It helps determine if a business has enough assets to cover its total debt.
Reporting: Liabilities are a key part of the Balance Sheet, which investors use to judge a company's risk.
Interest Tracking: Many liabilities come with interest; Bookkeeping Services Knoxville ensures these extra costs are captured accurately.
