Question

1)    What is a liability and how do they occur in a companies business?

2)    What are some types of liabilities?

3)    What distinguishes a "current" liability from a "long term" liability?

4)    Can a business incur a liability by "selling" a product or service?

5)    What is a contingent liability?   What has to exist for a contingent liability to be recorded in the accounting records?

6) What is working capital?

Answer 1

Ans.1. Liability is an obligation for the company to pay a certain amount to a certain person or to other person on order of that person. It results in outflow of Company's economic resources. Liabilities occur in a company as a result of past performance of the company e.g., bank loan, purchase on credit, etc.

Ans.2. Some types of liabilities are:

(i) Current Liability

(ii) Non-current Liability

(iii) Contingent Liability

Ans.3. Current liabilities are debts or obligations that need to be paid within a year. Non-current liabilities are debts or obligations that are due in over a year’s time.

Ans.4. Yes. A business can incur a liability by "selling" a product or service. These liabilities are warranty liabilities which can be categorized as contingent liability.

Ans.5. Contingent liabilities are liabilities that may occur, depending on the outcome of a future event. Therefore, contingent liabilities are potential liabilities. A contingent liability is only recorded if the liability is probable and the amount of the resulting liability can be reasonably estimated.

Ans.6. Working capital is the difference between a company’s current assets and its current liabilities. Therefore, Working Capital = Current Assets - Current Liabilities