Lesson #4 - The Second Element - LIABILITIES

Definition:
LIABILITIES are future sacrifices of economic benefits arising from present obligations as a result of past events.

Remember two key things here that give LIABILITIES their meaning: -

1. Future sacrifices of economic benefits
2. Present obligations

Firstly, "future sacrifices of economic benefits" means you have to give up CASH in the future.

Secondly, "present obligations" means you are currently, at this very moment, obliged to give that CASH up.

Examples:
1. Creditors (also known as Trade Payables)
Cash that you owe to your suppliers after you have bought something from them in credit, and you haven’t paid them yet.

2. Bank borrowings, bank loans or overdrafts
Money that you borrowed from a bank and that you are obliged to make repayments to on a regular basis.

3. Revenue received in advance (also known as Prepaid Revenues)
Revenue that your customers have paid you in advance, for example an invoice that was paid to you upfront or in advance, BEFORE you actually deliver the product or service. At the very moment that you receive the advance payment, it's a LIABILITY to you!

However, once you’ve done your part and deliver the product or service to the customer, then it is no longer a liability (it becomes "REVENUE" - we'll talk more about that later...)

Short Term or Long Term:
LIABILITIES can classified into Short Term or Long Term.

Short Term Liabilities = Current Liabilities = Liabilities that last for less than one year i.e. 12 months

Long Term Liabilities = Non-Current Liabilities = Liabilities that last for more than one year i.e. 12 months

The Nature of Liabilities:
I'm sure you've heard of something called "DEBITS" and "CREDITS". In accounting, "DEBIT" means "Left" and "CREDIT" means "Right".

Huh? So what? Why are you telling me this?

Just remember for now that LIABILITIES are CREDIT in nature.

Another thing to remember is - When LIABILITIES get BIGGER or INCREASE they will head in a CREDIT direction, as that’s in line with their nature. Conversely, when LIABILITIES get SMALLER or DECREASE, they will head in a DEBIT direction.

In Conclusion:

As LIABILITIES are cash that you are obliged to pay or that you owe someone else, let's pay tribute to LIABILITIES through a cheesy song!

Here it is! "IOU" by Lee Greenwood.

Enjoy!!!