liability Understanding 3 types of liabilities with examples

The obligations of the company are documented in the liabilities section of the balance sheet. This section is divided into three components, namely shareholders’ fund, non-current liabilities, and current liabilities. The primary focus is on shareholders’ fund.

To gain insight into share capital, let’s consider a fictional company called XYZ Corporation that issues 500 shares with a face value of Rs.20 each. In this scenario, the total share capital would amount to Rs.10,000/-, calculated by multiplying the face value by the number of shares.

The share capital of ARBL is Rs.17.081 Crs, as stated in the Balance Sheet, with a Face Value of Rs.1/-. This information can be found on the NSE website.

I can calculate the number of shares outstanding with the FV and share capital value. We know that:

Face Value * Number of shares = Share Capital

Therefore, 

Number of shares = Share Capital / Face Value 

 Hence in the case of ARBL, 

 Number of shares = 17,08,10,000 / 1

 = 17,08,10,000 shares

 The next line item on the Balance Sheet’s liability side is ‘Reserves and Surplus’. This contains earmarked funds for specific purposes, plus all the profits of ARBL, which amount to Rs.1,345.6 Crs. Be sure to refer to note 3, associated with this figure.

It is evident from the note that funds have been allocated towards three different types of reserves.

1. Capital reserves are generally held in reserve for long-term projects, and ARBL does not have a vast amount. While this money is owned by the shareholders, it cannot be disbursed to them.
2. ARBL has an Rs.31.18 Crs in the securities premium reserve, which is a fund for any money received from shareholders. 
3. All of ARBL’s accumulated profits, not yet allocated to shareholders, are located in the company’s general reserve. This money can be utilised as a cushion by the business. As it stands, there is Rs.218.4 Crores in its general reserves.

The following section focuses on the surplus – the profits acquired during the year.

1. According to the FY13 balance sheet at the opening line of the report, the surplus was recorded as Rs.829.8Crs. For this fiscal year, the profit of Rs.367.4 Crs has been added to the existing surplus balance. 
2. The way P&L and the balance sheet interact with one another highlights an important point – a strong connection between these three financial reports.
3. This emphasises that the balance sheet is assembled cumulatively, carrying forward each year’s figures.
4. The total of the previous year’s balance and this year’s profit amounts to Rs.1197.2 Crs. This figure can be used for different purposes.
5. A company initially shifts a sum of Rs.36.7 Crores from their surplus to general reserves, for potential use in the future.
6. After transferring to general reserves, they disbursed Rs.55.1 Crs as dividends, for which Rs.9.3 Crs had to be paid in dividend distribution taxes.
7. Having allocated the necessary funds, the company is left with a total closing balance of Rs.1095.9 Crs. This amount will be used as the starting balance for the following financial year (FY15).
8. The total Reserves and Surplus for the Fiscal Year 14 amounted to Rs.1345.6 Crs, compared to Rs.1042.7 Crs during the previous Financial Year. This sum is composed of Capital reserve, securities premium reserve, general reserves, and surplus from the said year.

The total shareholder funds present on the balance sheet’s liability side is composed of share capital and reserves & surplus; it represents the money belonging to shareholders.

 What are non-current liabilities? 

 Non-current liabilities are obligations of the company that are intended to be settled outside of 365 days from the balance sheet date, typically over a few years. These types of liabilities remain on the books for over a year after the reporting period. 

 Here is a snapshot of Amara Raja Batteries Ltd’s non-current liabilities.

 We will analyse the three kinds of non-current liabilities the company has.

The non-current liabilities section of the balance sheet is led by long-term borrowing (noted in item 4). This figure is crucially important not only to the balance sheet itself but also for many financial ratio calculations. In this module, we will go in-depth on these ratios.

Let us examine the ‘Long term borrowings’ note.

The note from the company clarifies that ‘Long term borrowings’ is, in fact, an interest-free sales tax deferment. This incentive is provided by the state government and will be settled by the company over a period of 14 years. To explain this further, the note below has been highlighted in red.

It is beneficial to know that many companies have no long-term borrowings. However, one must also consider why this may be the case. Could it be due to a lack of interest from lenders? Or that the business is not attempting to grow? The latter will be examined as part of the balance sheet analysis later in the module.

Remember, when we examined the P&L statement, ‘Finance Cost’ was listed as a line item. If the company has taken on large amounts of debt, then its finance cost will be correspondingly high.

The next non-current liability is ‘Deferred Tax Liability’. This is an allowance made by the company in anticipation of having to pay more taxes at some point in the future. By setting aside some funds, they are prepared for any impending tax payments that could arise. But why would a company accept this burden for current year taxation?

According to the Company’s Act and Income Tax, this is a result of the divergent approaches to depreciation. However, in order to stay focused on our aim of understanding financial statements, we won’t delve any further. Nevertheless, kindly bear in mind that deferred tax liability arises from how depreciation is dealt with.

The final item of the non-current liability is ‘Long term provisions’. Generally, this money is reserved to be used for employee benefits like gratuity, leave encashment, and provident funds.

– What are Current Liabilities? 

 Current liabilities refer to a company’s obligations that are due to be settled within 365 days. The word ‘current’ implies these debts will soon be paid off. On the other hand, non-current liabilities extend beyond a year.

When you decide to purchase a phone using a credit card, you become liable to pay back the company in just a few months. However, if you buy an apartment and take up a home loan that lasts 15 years, it turns into your long-term debt.

ARBL’s current liabilities can be seen here. This listing gives an overview of their current obligations. 

It is evident that there are 4 line items within the current liabilities. The first of these is short-term borrowings, which are usually taken on by the corporation to cover day-to-day cash flow needs (also referred to as working capital). Note 7 outlines what short-term borrowings mean; here is an extract from it:

Clearly, the State Bank of India and Andhra Bank both offer short-term loans to meet working capital needs. It is noteworthy that these come with a low borrowing capacity of Rs. 8.3 Crs.

The next item on the balance sheet is Trade Payable – commonly referred to as Account Payable – amounting to Rs.127.7 Crs. This figure represents the obligations owed to suppliers, such as those providing raw materials, utilities, and stationery. Note 8 provides further details on this action.

The next line on the statement details ‘Other current liabilities’ totalling Rs. 215.6 Crs. This typically refers to statutory requirements and liabilities that are not linked with the company’s business activities. Note 9 provides additional information about this item:

The last entry in current liabilities is ‘Short term Provisions’ amounting to Rs.281.8 Crs. This pertains to similar expenses as long-term provisions, including benefits for employees like gratuity, leave encashment and provident funds. An identical footnote applies to both ‘Short term Provisions’ and ‘Long term Provisions’.

Note 6 provides information on both long and short-term provisions, so it is pretty lengthy.

From a user of financial statements viewpoint, it is essential to understand that the line items (both short and long-term) concern employees and related benefits. It is advised to keep track of the associated notes for further details.

We have already examined half of the balance sheet, broadly categorised as its Liabilities side. Let us revisit the balance sheet to gain a better understanding.

Clearly,

Total Liability = Shareholders’ Funds + Non Current Liabilities + Current Liabilities

= 1362.7 + 143.03 +  633.7

Total Liability = Rs.2139.4 crores