Known Liabilities: Definition & Types

Known Liabilities: Definition & Types
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  • 0:01 What Are Known Liabilities?
  • 0:59 Known Liabilities by Agreement
  • 2:00 Known Liabilities by Contract
  • 2:59 Known Liabilities by Law
  • 3:58 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, you'll learn about known liabilities. We'll discuss three types of known liabilities: liabilities by agreement, liabilities by contract, and liabilities by law. You'll also learn which financial statement these liabilities are listed on.

What are Known Liabilities?

Sam is interested in starting a computer repair business. He talks to a loan officer about borrowing money to start the business. The loan officer tells Sam he needs to provide a balance sheet of the known assets and liabilities. Sam tells the loan officer he's familiar with known assets, which are owned items with a specific value, but he's unclear about known liabilities. The loan officer starts by defining liabilities, which are obligations the business will owe.

Known liabilities are liabilities that have a specific dollar amount that he will need to pay. These types of liabilities are created by agreement, contract, or law.

For the remainder of this lesson, we'll explain which financial statement you'll find known liabilities listed on. You'll also learn about the three categorizations of known liabilities: agreement, contract, and law, and we'll discuss examples of each.

Known Liabilities by Agreement

Liabilities are obligations that are owed. These obligations are found on the balance sheet and are created by agreement, contract, or law. Let's first look at liabilities by agreement.

A liability by agreement is an arrangement between two or more parties that is not enforceable by law. For example, let's say Sam's Computer Repair decides to partner with another computer repair shop to fix more complicated repairs brought in by their customers. Rather than turn those customers away, Sam's will take in the item and then send it to the other shop for repair. Sam and the computer repair shop casually make an agreement; they do not have any specific terms on the time frame for repair or payment.

Once the other computer repair shop fixes the item, they call Sam and tell him how much he owes, which creates a liability by agreement. You will see this type of liability listed on the balance sheet as an accounts payable. Now let's look at a known liability by contract.

Known Liabilities by Contract

Another type of known liability is a liability by contract. For example, Sam would like to start selling new computers to customers whose computer cannot be fixed. Sam contacts a computer manufacturer. The computer manufacturer gives Sam a contract to review their terms. Sam signs the contract and thanks them for the approval. Being able to sell new computers will definitely increase his sales.

Once Sam purchases computer systems and starts receiving bills, an obligation or liability by contract has been created. Sam is expected to pay the bill based on the terms of the legally binding contract. This type of liability is also listed as an accounts payable.

The loan Sam requests from the bank is also considered a liability by contract since there are terms Sam must legally abide by. This type of liability is listed as a notes payable. Let's review the last type of liability, liabilities created by law.

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