INTERPRETATION OF LIABILITIES 1. Liabilities defined and classified.—A liability is a claim against a debtor which gives to the creditor a right of action at law. Liabilities are to be dis tinguished from accountabilities. Thus, a factor who receives a consignment of goods from a shipper is accountable to the shipper for the goods or the pro ceeds of sales. No liability, however, attaches to the consignee beyond that of taking ordinary care of the property of the shipper, until such time as he has sold a portion of the goods and collected the proceeds. Then the relation of liability arises.
Under American practice the right hand side of the balance sheet, as we have seen, contains two classes of rights, those of the 'creditors, and those of the pro prietor.
The reader has seen in the Text on "Accounting Practice," that capital is not to be considered as a strict liability. Liabilities are broadly classified in two groups,—fixed and current. The former are those liabilities which have more than one year to run from the date of the balance sheet; the latter comprise those liabilities which must be liquidated out of the current assets and are payable at the latest within one year. Liabilities are also divided into funded debt and unfunded debt. Funded debt consists of debt for which definite provision for repayment has been made. A funded debt is usually secured by a mortgage or other lien. Unfunded debt is that debt which rests upon the general credit of the business and for which no definite provision for repayment has been made.
This classification as between funded debt and un funded debt is not adopted by all. For example, there are some who class debenture bonds as funded debt, even tho no provision may have been made for the ultimate repayment of the debentures.
Fixed liabilities are also called capital liabilities be cause they represent the part of the capital income of an undertaking which has been invested in assets of a permanent character or capital assets. The reader has already seen from the Text on "Corporation Finance" the difficulty in many instances of deter mining from the mere names the character of the vari ous classes of financial instruments or evidences of debts which are found in practice. In the present volume, we are not concerned with the nature of these evidences of debts or with the security underlying them. From the accounting standpoint, we are in
terested in seeing that the character of the debt is stated clearly in the accounts.
2. Bonded debt.—A bonded debt of a firm con sists of that debt which is evidenced by an issue of bonds. It may be secured or unsecured and provision for its repayment may or may not be made. In order to determine the nature and kind of bonds shown in a financial statement, it may be necessary in some in stances to obtain an abstract of the instrument and indenture underlying these bonds, assuming, right fully, that such an instrument' exists. Bonded debts may be secured by a pledge of real property or by a pledge of personal property. The distinguish ing features of each class will be the security, if any, underlying the debt; the rate of interest; the date of maturity and the interest dates. All obligations of a business which agree in all respects with the four classifications mentioned above should be shown in the same account.
Where a debt is secured by a mortgage or a pledge of personal property, the property covered by the mortgage should be plainly indicated in the title of the account, thus, "first mortgage 5 per cent bonds," or "collateral trust 5 per cent bonds." Where a mort gage has been issued underlying the bonds, it is evi dent that there has been a definite pledge of a fixed amount of the company's property and the real lia bility is the amount of the mortgage and not the amount of the bonds which may be issued and out standing. When the bonds are secured by a mort gage, unissued bonds differ from unissued stock. The unissued bonds have a value, because underlying them there is 'a pledge of property and it would be preferable to treat unissued bonds in a balance sheet as an asset, because they represent a security which the officers of the organization may dispose of at any time. They may also be used at any time as security for advances or for other obligations or debts. Tkie entire authorized issue of bonds would appear as a lia bility for the full amount of the mortgage shown. Unissued stock, however, has no value, nor does value attach to it until it has been exchanged for cash or its equivalent. Therefore, it is important that the amount of all mortgages and pledges of property to secure evidences of debt be set forth clearly in the balance sheet.