Liabilities and Equity

The Right Side of the Equation

Liabilities and equity together answer: who financed the assets? The distinction is legal: creditors have a fixed, contractual claim (interest and principal, due on schedule); owners have a residual, flexible claim (dividends are discretionary, and if the firm fails, owners are last in line).

Current liabilities — obligations due within one year:

• Trade payables (accounts payable): amounts owed to suppliers for goods or services received.
• Short-term borrowings: bank overdrafts, revolving credit lines.
• Accrued expenses: costs incurred but not yet invoiced — wages earned by employees between the last pay date and the balance-sheet date, interest accrued on loans.
• Current portion of long-term debt: the slice of a mortgage or bond that must be repaid within the next twelve months.
• Unearned revenue (deferred revenue): cash received for services not yet delivered — a liability because the firm still owes the service.

Non-current liabilities — obligations beyond one year:

• Bonds payable and long-term loans: the backbone of debt financing.
• Lease liabilities (under IFRS 16): the present value of future lease payments.
• Pension obligations: the firm's promise to pay future retirement benefits.
• Deferred tax liabilities: taxes owed but not yet due because of timing differences.

Equity — the owners' section:

• Share capital (contributed or paid-in capital): cash or assets owners invested.
• Share premium (additional paid-in capital): the excess over par value.
• Retained earnings: cumulative net profit minus cumulative dividends. The self-financing engine.
• Other reserves: revaluation surplus, foreign-currency translation, hedging reserves.

$$\text{Equity} = \text{Share capital} + \text{Retained earnings} + \text{Reserves}$$

The capital-structure question — how much debt versus equity — is the most consequential financing decision: more debt means higher fixed payments (riskier) but potential tax shields and amplified returns on equity; more equity means lower risk but diluted ownership and usually higher cost of capital. There is no universal right answer — the right mix depends on cash-flow stability, tax rates, and how close to the edge the firm can safely operate.

Two kinds of claim

Tip: Accrued expenses are the easiest liability to forget and the easiest for an auditor to find: wages earned but unpaid at closing date exist whether or not an invoice does. Search for obligations by events, not by paperwork.