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Current, non-current and contingent liabilities
Classification of Liabilities
Different types of liabilities can fall under the following three categories −
Current liabilities are the liabilities that are due and payable within one year. These are also known as "short-term liabilities".
Non-current liabilities are the liabilities that have to be cleared after a year or more, hence these are also known as "long-term liabilities".
Contingent liabilities are a separate category of liabilities that may or may not arise, depending on a certain event.
Current liabilities are debts or obligations that need to be paid within a year. Current liabilities should be closely watched by management to ensure that the company possesses enough liquidity from current assets to guarantee that the debts or obligations can be met.
Examples of current liabilities include −
Short-term loans and Interest payable
Bills and Accounts payable
Income taxes payable
Bank account overdrafts
Current liabilities are an important factor in calculating short-term liquidity measures.
Non-current liabilities are the financial obligations or debts that have to be repaid after a year. are due in over a year’s time. Companies normally get into long-term debts to fund new projects and expand their business. Sometimes companies take long-term debts to finance their short-term capital requirements.
Long-term liabilities play a crucial role in determining a company’s long-term financing prospects and solvency. If a company defaults on its long-term liabilities, then it may run the risk of becoming insolvent.
Examples of non-current liabilities include −
Deferred tax liabilities
Corporate Bonds payable
Long-term notes payable
Contingent liabilities may or may not occur because it depends on the outcome of a future event on which the company does not have its full control. Companies need to account for contingent liabilities because they are potential liabilities which they may have to suffer in the future.
Suppose an Indian pharmaceutical company that supplies medicines in the US market is facing a lawsuit for unlawful business practices. Now, the outcome of such an event may be positive or negative because the verdict is beyond the company's control. If the verdict comes against the company, then it will have to pay the penalty which will become a financial liability. On the other hand, if the verdict comes in favor of the company, then there will be no liability. There is a 50% of chance of the verdict going either way. Hence, the company must show this contingent liability in its books.
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