What constitutes a liability?

A liability is defined as a present obligation that arises from past events, which can result in the outflow of resources in the future. This definition is anchored in accounting standards, which require that liabilities be recognized on a company's balance sheet when an obligation is identifiable and measurable.

When a business engages in transactions—such as borrowing money, purchasing goods on credit, or incurring expenses—it creates obligations that must be settled in the future, typically through the payment of cash or the provision of goods or services to another party. These obligations are considered liabilities because they represent claims against the company's assets.

In contrast, future income from sales does not represent an obligation; rather, it is potential revenue that the business hopes to receive. Provisions for future investments are not classified as liabilities because they are not obligations resulting from past transactions but rather anticipations of future outflows. Owner's equity, while an important component of the balance sheet, represents the owners' residual interest in the assets of the business after deducting liabilities, and it is not an obligation of the business. Therefore, the understanding that a liability is a present obligation from past events is crucial for proper financial reporting and analysis.