Liability: Definition, Accounting Reporting, & Types

accounts payable

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The Language of Business

Metro Corporation collected a total of $5,000 on account from clients who owned money for services previously billed. We want to increase the asset Equipment and decrease the asset Cash since we paid cash. On January 1st, 2020, Sherry took out the money from her savings for $100,000 to start her skincare business. Determine the asset, liability, and equity value of her skin clinic as of January 1st, 2020. This transaction affects only the assets of the equation; therefore there is no corresponding effect in liabilities or shareholder’s equity on the right side of the equation. Regardless of how the accounting equation is represented, it is important to remember that the equation must always balance. Bankrupt, its assets are sold and these funds are used to settle its debts first.

  • It is calculated by subtracting retained earnings from total equity.
  • Any user of a balance sheet must then evaluate the resulting information to decide whether a business is sufficiently liquid and is being operated in a fiscally sound manner.
  • But if you’re locked into a contract, and you need to pay a cancellation fee to get out of it, this fee would be listed as a liability.
  • Indicate the order the financial statements are prepared.

This is used extensively in entries, where an increase or decrease on one side of the equation may be explained by an increase or decrease on the other side. Purchase of equipment, for example, will increase assets. The accounting equation creates a double entry to balance this transaction. If cash were used for the purchase, the increase in the value of assets would be offset by a decrease in the same value of cash. If the equipment were purchased using debt, the increase in assets would be balanced by increasing the same amount in loans or accounts payable.

Shareholders’ Equity

Non-current liabilities are due in more than one year and most often include debt repayments and deferred payments. For each financial transaction made by a business firm that uses double-entry accounting, a debit and a credit must be recorded in equal, but opposite, amounts. According to Table 1, cash increases when the common stock of the business is purchased.


The expired portion of prepaid accounts is reported on the income statement as an expense. Considering the name, it’s quite obvious that any liability that is not near-term falls under non-current liabilities, expected to be paid in 12 months or more. Referring again to the AT&T example, there are more items than your garden variety company that may list one or two items. Long-term debt, also known as bonds payable, is usually the largest liability and at the top of the list. If a business buys raw materials and pays in cash, it will result in an increase in the company’s inventory while reducing cash capital .


The ability to read financial statements requires an understanding of the items they include and the standard categories used to classify these items. The accounting equation identifies the relationship between the elements of accounting.

transaction are equal

See how each impacts the sheet without upsetting the basic equality. This increases the fixed assets account and increases the accounts payable account. Thus, the asset and liability sides of the transaction are equal.