What is a Liability?

A liability is a legally binding obligation payable to another entity. Liabilities are incurred in order to fund the ongoing activities of a business. Larger and longer-term liabilities are used to pay for the acquisition of assets that can expand the capacity and capabilities of a business. Examples of liability accounts are trade payables, accrued expenses payable, and wages payable.

What is Debt?

Debt is an amount owed for funds borrowed. The lender agrees to lend funds to the borrower upon a promise by the borrower to pay interest on the debt, usually with the interest to be paid at regular intervals. A person or business acquires debt in order to use the funds for operating needs or capital purchases. Examples of debt accounts are short-term notes payable and long-term debt.

Comparing Liabilities and Debt

The main difference between liability and debt is that liabilities encompass all of one’s financial obligations, while debt is only those obligations associated with outstanding loans. Thus, debt is a subset of liabilities. In addition, debt obligations require the debtor to pay back the principal on the loan plus interest, whereas there is no interest payment associated with most other types of liabilities. A third difference is that most liabilities are short-term in nature and so appear in the current liabilities section of the balance sheet, whereas debt may be reported in both the current liabilities and long-term liabilities sections of the balance sheet, depending on when loan payments are due. Finally, liabilities are measured with liquidity ratios to see if they can be paid when due, while debt is measured with leverage ratios to see if a firm is at risk of becoming insolvent.

Presentation of Liabilities and Debt

The liabilities and debts of an organization are reported on its balance sheet, as of the date of the balance sheet. The amounts presented on the balance sheet are divided into current liabilities (due within one year) and long-term liabilities (due in more than one year). When combined with the reported equity total, liabilities always match the reported total assets on the balance sheet.