Liability
The literature meaning of liability is an obligation. Now, obligation in simple terms means , an act of being binded, socially mentally or financially, for something or being obliged. In financial aspect, it may be defined as a kind of financial settlement that is entitled between two entities(can be persons or banks), according to which one has to pay the value of the service, asset etc , in near future or as per decided. The things or the structures over which the liability holds can be an asset or other services yielding economic benefits in future.
Relation between Asset and Liability
The equation which relates the two is:
Assets= Liability + Owner’s equity*
Owner’s equity- For understanding this term , we need to get an insight into the term-‘equity’. Equity may be defined as the difference of the value of assets and the cost of liability owned for something.
Example
Mr. Amit owes a bike of Rs. 50,000, but he owes Rs. 10,000 on that bike,then the equity on the bike is Rs.40,000. Equity can also be negative , in case liability exceeds the price of asset. So in short, an owner’s equity may be defined as equity which remains for the owner after all the liabilities have been paid off and all the creditors have been reimbursed.
Types of liabilities
Liabilities may be classified broadly into two categories:
Current liabilities - These types are the ones which are expected to get liquidated within a year or less. Examples can be short term payments of a bond to be paid this year,wages etc
Long-term liabilities - These types are , as the name suggests , liquidate after a long time , usually more than a year. Examples can be long term bonds, long term leases etc
Hence, liabilities are not mandatory, yet legal parameters used in banking.
