Define: Liability

Quick Summary of Liability

The state of being responsible for something, especially by law.

Liability is an obligation that an individual must pay according to the law. For instance, if you are negligent and your negligence causes injury to another person you are legally liable to compensate them for their injuries. Personal injury claims can decide the liability of each injured party.

Consider, however, different states will have different means to allocate damages for injuries. Some states use a contributory negligence system, which allows that if the plaintiff contributed to his injury (in some states) the plaintiff will be prevented from collecting any damages. Other states use a pure comparative negligence system, which allows the plaintiff to collect damages but reduces the amount by their contribution or fault. Other states use a comparative negligence system but the plaintiff can only collect compensation if they are 49% or less at-fault for their injuries; other states allow the plaintiff to receive compensation if they are less than 50% at-fault.

Because state laws vary for how compensation may be allocated based on each party’s liability if you have been injured and you are partially at-fault for your injuries you should talk to a personal injury lawyer.

In cases of civil liability, the party who is wronged is entitled to the redress allowed by law, whereas in cases of criminal liability, the wring doer is made to undergo the penalty prescribed for the wrong.

Liability means and signifies responsibility for an act or omission. Thus, he who commits a wrong is said to be liable for it.  Liability, in the words of Salmond, is the bond of necessity that exists between the wrong-doer and the remedy for the wrong. This remedy may be either civil or criminal, and thus, liability may be civil liability or criminal liability.

In order to win a lawsuit, the suing party (plaintiff) must prove the legal liability of the defendant if the plaintiff’s allegations are shown to be true. This requires evidence of the duty to act, the failure to fulfil that duty and the connection (proximate cause) of that failure to some injury or harm to the plaintiff. Liability also applies to alleged criminal acts in which the defendant may be responsible for his/her acts which constitute a crime, thus making him/her subject to conviction and punishment.

Example: Jack Jumpstart runs a stop sign in his car and hits Sarah Stepforth as she is crossing in the cross-walk. Jack has a duty of care to Sarah (and the public) which he breaches by his negligence, and therefore has liability for Sarah’s injuries, giving her the right to bring a lawsuit against him. However, Jack’s father owns the automobile and he, too, may have liability to Sarah based on a statute which makes a car owner liable for any damages caused by the vehicle he owns. The father’s responsibility is based on “statutory liability” even though he personally breached no duty. A signer of a promissory note has liability for money due if it is not paid and so would a co-signer who guarantees it. A contractor who has agreed to complete a building has liability to the owner if he fails to complete on time.

In the most general sense, a liability is anything that is a hindrance, or puts individuals at a disadvantage.

Financial Accounting

In financial accounting, a liability is defined as an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.

• They embody a duty or responsibility to others that entails settlement by future transfer or use of assets, provision of services or another yielding of economic benefits, at a specified or determinable date, on the occurrence of a specified event, or on-demand;
• The duty or responsibility obligates the entity leaving it little or no discretion to avoid it; and,
• The transaction or event obligating the entity has already occurred.

Liabilities in financial accounting need not be legally enforceable, but can be based on equitable obligations or constructive obligations. An equitable obligation is a duty based on ethical or moral considerations. A constructive obligation is an obligation that can be inferred from a set of facts in a particular situation as opposed to a contractually based obligation.

The accounting equation relates to assets, liabilities, and owner’s equity:

Assets = Liabilities + Owner’s Equity

The accounting equation is the mathematical structure of the balance sheet.

The Australian Accounting Research Foundation defines liabilities as the future sacrifice of economic benefits that the entity is presently obliged to make to other entities as a result of past transactions and other past events.

Probably the most accepted accounting definition of liability is the one used by the International Accounting Standards Board (IASB). The following is a quotation from IFRS Framework:

A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits – F.49(b)

Regulations as to the recognition of liabilities are different all over the world but are roughly similar to those of the IASB.

Examples of types of liabilities include: money owing on a loan, money owing on a mortgage, or an IOU.

Difference between liability and debt

Debt is money borrowed from someone that has to be paid back, plus interest. You probably have this in the form of a mortgage or car payment or credit card payment. Companies have them in the form of mortgages, bonds, and bank loans.

A liability is something owed to someone, but is not necessarily debt. Accounts payable, for instance. The company bought some equipment or supplies and has 30 days to pay. A personal example might be the meal you eat at a restaurant, while you eat it and before you pay for it. During that (short) time, it is a liability. You’ve gained a benefit, the meal, but haven’t paid for it.

Accrued expenses are another example. This one’s easy (okay, it was a stretch with that meal example). You use electricity supplied by a utility, but only pay for it once a month. Employee salaries are another example. They’ve worked and need to be paid, but it isn’t pay day yet.

Unearned revenue is a third example, though not all companies have it. This is where somebody has paid for something, but the company hasn’t delivered what it has promised, yet. Think of a gift card. You’ve given Borders (for example) $25 cash, but they haven’t delivered any books to anyone. Prepaid subscriptions are another example.

Thus, when looking at a balance sheet and seeing if the company has debt, don’t confuse these other liabilities as debt.

Classification Of Liabilities

Liabilities are reported on a balance sheet and are usually divided into two categories:

• Current liabilities — these liabilities are reasonably expected to be liquidated within a year. They usually include payables such as wages, accounts, taxes, and accounts payables, unearned revenue when adjusting entries, portions of long-term bonds to be paid this year, short-term obligations (e.g. from purchase of equipment), and others.
• Long-term liabilities — these liabilities are reasonably expected not to be liquidated within a year. They usually include issued long-term bonds, notes payables, long-term leases, pension obligations, and long-term product warranties.— In these liabilities, a company has to pay after a fixed or long period For ex:- Long term bank loans up to 1yr or more than one 1yr.

Liabilities of uncertain value or timing are called provisions – see Provision (Accounting).

In Law

In law a legal liability is a situation in which a person is liable, such in situations of tort concerning property or reputation and is therefore responsible to pay compensation for any damage incurred; liability may be civil or criminal. See Strict liability. Under English law, with the passing of the Theft Act 1978, it is an offence to dishonestly evade a liability. Compensation for damages usually resolved the liability. Vicarious liability arises under the common law doctrine of agency – respondeat superior – the responsibility of the superior for the acts of their subordinates.
In commercial law, limited liability is a form of business ownership in which business owners are legally responsible for no more than the amount that they have contributed to a venture. If for example, a business goes bankrupt an owner with limited liability will not lose unrelated assets such as a personal residence (assuming they do not give personal guarantees). This is the standard model for larger businesses, in which a shareholder will only lose the amount invested (in the form of stock value decreasing). For an explanation see business entity.
Manufacturer’s liability is a legal concept in most countries that reflects the fact that producers have a responsibility not to sell a defective product. See product liability.

Bank Account Example

Money deposited with a bank becomes a liability of the bank, because the bank has an obligation to pay the depositor the money deposited; usually on demand. (The money deposited is an asset for the depositor; but this asset will not be recorded by the bank because it is not the bank’s asset. If the depositor maintains accounting records separate and apart from the bank account maintained by the bank, only then will the asset be recorded.)

A debit increases an asset; and a credit decreases an asset. A debit decreases a liability; and credit increases a liability.

When a bank receives a deposit it credits a liability account called “Deposits” and credits the depositor’s bank account for the same amount (the bank’s “Deposits” account is the sum of all of the amounts credited to all of its customer’s individual bank accounts). A deposit received by a bank is credited because the bank’s liability to its customer, the depositor, increases. When a bank informs its depositor that it has debited the depositor’s bank account, it means that the depositor’s bank account has been decreased by the amount debited.

Remedial Liability

Whenever the law creates a duty, it also seeks to enforce the fulfilment of such a duty. Therefore, the law imposes remedial liability on him who fails to perform such a duty. But there are some exceptional circumstances when the law might accept the right of the plaintiff, and yet it may not enforce it.

Disclaimer

This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.

This glossary post was last updated: 29th March, 2024.