Liabilities, Equity & Capital: Types, Accounting & Real-World Impact

Core Concepts: Liabilities vs. Equity

1. Definitions & Classification

Liabilities are obligations a business must settle in the future (e.g., loans, unpaid bills). Equity represents the owner’s residual claim after liabilities are deducted from assets.

Classification of Liabilities

Classification of Equity

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2. Accounting for Liabilities

Key Types & Journal Entries

A. Current Liabilities

B. Non-Current Liabilities

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3. Accounting for Equity

A. Share Capital

• Issued at Par: Recorded at face value (e.g., ₹100 shares).
• Issued at Premium: Excess over par credited to Share Premium Account.
• Issued at Discount: Rare; deducted from share capital (not allowed in Nepal for public companies).

Journal Entry for Share Issuance

B. Reserves & Retained Earnings

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4. Dividends: Declaration, Payment & Accounting

Dividends reduce retained earnings and are a liability until paid.

Journal Entries

1. Declaration: Dr. Retained Earnings (₹50,000) Cr. Dividend Payable (₹50,000)
2. Payment: Dr. Dividend Payable (₹50,000) Cr. Cash (₹50,000)

Real-World Example: NEPSE Listed Companies

• NMB Bank declares ₹10/share dividend annually.
• Everest Bank uses retained earnings to fund expansion instead of dividends.

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5. Worked Example: Kathmandu Retail Shop

Scenario:

• Share Capital: 5,000 shares issued at ₹150 (₹100 par).
• Loan: ₹200,000 from Nepal Bank (5-year term).
• Profit: ₹80,000 retained as Revenue Reserve.
• Dividend: ₹30,000 declared (unpaid).

Journal Entries

Balance Sheet Extract (Equity & Liabilities)

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In the Real World

1. eSewa & Khalti (Digital Payments)

   • Liability Accounting: When you pay utility bills via eSewa, the platform records unsettled transactions as Accounts Payable until NTC/NEPALGAS clears them. For merchants, pending refunds are liabilities until processed.

2. Daraz Nepal (E-Commerce)

   • Long-term Debt: Daraz’s parent (Alibaba) may have deferred revenue (liability) for prepaid orders not yet fulfilled. Inventory bought on credit is Accounts Payable.
   • Equity Impact: Reinvested profits (retained earnings) fund warehouse expansions in Kathmandu.

3. NMB Bank (Financial Services)

   • Loan Liabilities: When you take a ₹500,000 home loan, NMB records it as Long-term Loan Payable to you. Interest accrued but unpaid is a current liability.
   • Shareholder Equity: NMB’s ₹60/share dividend (2023) came from retained earnings after setting aside reserves for bad loans.

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Exam Tip

1. Memorize the 3 Golden Rules for Liabilities:

   • Increase in liability → Credit the account (e.g., loan received).
   • Decrease in liability → Debit the account (e.g., loan repayment).
   • Dividends are expenses (reduce retained earnings) but become liabilities only when declared.

2. Common Mistakes to Avoid:

   • Mixing Share Premium with Revenue: Share premium is equity, not income.
   • Ignoring Discount on Shares: In Nepal, discounts are rare but if issued, they reduce share capital (not expense).
   • Forgetting Accrued Expenses: Salaries or interest owed but not paid are liabilities (e.g., Salaries Payable).

3. Exam Question Patterns:

   • Trace the flow: Start from a transaction (e.g., "Issued 1,000 shares at ₹200") → Journal → Ledger → Balance Sheet.
   • Compare liabilities: Given a scenario, classify whether a debt is current or non-current.
   • Dividend calculations: Always check if dividends are declared (liability) or paid (expense).

4. Numerical Weightage:

   • 30% of Unit 7 marks test journal entries for liabilities/equity.
   • 25% test balance sheet preparation (equity section).
   • 20% test dividend accounting (declaration vs. payment).
   • 15% test real-world classification (e.g., "Is a supplier’s 6-month bill a current or non-current liability?").

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Final Note: Liabilities and equity are the backbone of solvency. In Nepal, businesses like NMB Bank and Daraz rely on debt financing (liabilities) for growth while retained earnings (equity) ensure stability. Master this unit, and you’ll ace questions on financial health, dividend policies, and compliance with Nepal’s Companies Act (2063).