Organizations engage in activities that obligate them to make future payments of cash or to provide goods or services. Most obligations are reported as liabilities on a company’s balance sheet. Liabilities result from transactions with creditors, suppliers, customers, employees, and others.
An organization incurs debt when it borrows from creditors. For example, a company may borrow from a bank, another company, or an individual. The lender agrees to provide resources to the borrower. In exchange, the borrower signs a note (a contract), promising to repay the amount borrowed (the principal) plus interest. In addition to contracting with creditors, organizations contract with suppliers, employees, and other providers of goods and services. Retail stores, for example, often acquire merchandise on credit from manufacturers and agree to pay for the goods in the near future. Companies also contract with their employees, exchanging wages for labor. Some compensation, such as retirement benefits, may be deferred to the future. Obligations to creditors, suppliers, and employees are all part of an organization’s liabilities.
The term liabilities refers to an organization’s obligations to deliver payments, goods, or services in the future. A liability links a past event (receiving something of value) and a future event (giving value back for what was received). So, three attributes define a liability for an organization: (1) a present responsibility exists to transfer resources to another entity at some future time, (2) the organization cannot choose to avoid the transfer, and (3) the event creating the responsibility has already occurred.
Exhibit 1 presents the liabilities reported on the balance sheet of Mom’s Cookie Company. The liabilities are like those of most companies. They include obligations to lenders (Notes Payable and Interest Payable), suppliers (Accounts Payable), employees (Wages Payable), and customers (Unearned Revenue).
Exhibit 1 Balance Sheet Presentation of Liabilities for Mom’s Cookie Company
Many of the liabilities reported by a company are associated with its operating activities. These liabilities result from transactions with suppliers, employees, and customers and involve resources used to produce and sell products. These obligations will be considered in a future chapter that examines operating activities. This chapter focuses on liabilities resulting from borrowing money from creditors.