Financial Accounting: In an Economic Context

WHAT IS A LIABILITY?

The FASB has defined liabilities as “probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” The board commented further that all liabilities appearing on the balance sheet should have three characteristics in common: (1) They should be present obligations that entail settlements by probable future transfers or uses of cash, goods, or services; (2) they should be unavoidable obligations; and (3) the transaction or event obligating the enterprise must have already happened.¹

While the FASB's definition makes the measurement of most liabilities relatively straightforward, the liabilities listed on the balance sheet do encompass a wide variety of items, including credit balances with suppliers, debts from borrowings, services yet to be performed, withholdings from employees' wages and salaries, dividend declarations, product warranties, deferred income taxes, and a number of complex financing arrangements. As we will discuss later, there is some question whether all these items are liabilities in an economic sense as well as whether all the economic liabilities of a company are included on its balance sheet.

1. Financial Accounting Standards Board (FASB), “Elements of Financial Statements of Business Enterprises,” Statement of Financial Accounting Concepts No. 3 (Stamford, Conn.: FASB, 1980), pars. ...