Liabilities are legal obligations that a person or company owes to another company or individual. Liabilities can be settled through the trade of goods, monetary funds, and services.
There are three types of liabilities – current, non-current, and contingent liabilities. These types are based on the period when they have to be paid or become payable.
The confusion regarding current vs noncurrent liabilities persists. Why? It will be discussed later in this article, but how these liabilities differ from each other is equally important to know.
Classification of liabilities
Current Liabilities: They are normally short-term liabilities that are supposed to be paid within one year.
Non-current liabilities: As the name suggests, non-current liabilities are the ones that should be paid after 12 months, or the time of these liabilities can be expected to extend for a specified period.
Contingent liabilities: The liabilities that involve dependencies that relate to future events are called contingent liabilities.
Current liabilities, as mentioned above, are short-term ones. They are the debts and obligations that have to be paid in under a one-year time. They are also monitored by the management to make sure that the person or the particular company taking debt is capable enough to return it within one year, or that the company possesses enough current asset liquidity that the obligation or the debt requirement would be met in the provided time limit.
Companies mostly rely on their current assets – which are generally separated from the company’s resources – to finance their ongoing projects and to pay running expenses related to such projects.
Examples of current liabilities include:
- Interest payable
- Account payable
- Bills payable
- Income taxes payable
- Accrued expenses
- Short-term loans
- Bank account overdrafts
Long-term liabilities, also known as non-current liabilities are the obligations or debts that are due after one year or 12 months. They can be extended as the company deems fit. For the purchase of ongoing project assets, companies need handsome capital to finance the need of the company. Due to this reason, they often acquire long-term debt for immediate investment to finance big ventures and projects.
Long-term liabilities play a vital role in determining the company’s solvency. If in the long run, the company is unable to repay the long-term liabilities, when they become payable, then the company may have to face a solvency crisis.
Examples of non-current liabilities include:
- Long-term payable notes
- Bonds payable
- Mortgage payable
- Deferred tax liabilities
- Capital leases
As mentioned earlier, the liabilities that are dependent on future events are called contingent liabilities. For instance, if the company is a defense against a $100,000 lawsuit, then the company has to pay the liability if the verdict of the lawsuit is recorded against it. However, if the lawsuit is decided in favor of the defendant, then there is no chance of any contingent liability arising.
According to the accounting standards, the contingent liabilities would only be recorded if there is a 50% chance of liability to be levied. In such cases, the amount of the liability can be estimated and has to be mentioned in the balance sheet.
Examples of contingent liabilities include:
- Product awareness
How to define current vs non-current liabilities
You must have gathered enough information about current and non-current liabilities through the definitions mentioned above. Just to recall, current liabilities are the payable liabilities that a company bears on its current assets. For instance, half-yearly or yearly loans, payments due to vendors, income taxes, and employee benefits that have to be paid within 12 months or less. On the other hand, long-term liabilities become payable beyond the period of a year or 12 months including banknotes, leases, pension benefit obligations, employee benefits, etc.
Current liabilities are recorded separately in the classified balance sheet. Similarly, the short-term and long-term assets should be mentioned in the balance sheet.
It makes sense to prepare a balance sheet to know how many current assets and liabilities you will have at the end of the year, and how much capital you need to pay in liabilities within a year.
The amount you get from current liabilities is used to find two financial ratios: working capital ratios and current ratios.
The working capital can be obtained by subtracting current liabilities from the number of current assets. Meanwhile, the current ratio can be found by dividing current liabilities by the number of current assets.