Liability Example


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Here's the second example for George's Catering, an example of a liability:

b) George realizes that he needs more money to create a really high-quality catering business. Yet he does not have any more personal funds available to invest in the business. He decides to take a loan from the bank to the value of $5,000.

Loan from the Bank

As you can see, $5,000 more cash is available. This cash was obtained by creating a liability (debt). External parties (the bank) now have a $5,000 claim to the total assets of the business. George’s Catering will have to pay back the $5,000 in the future.

In our previous example the assets were funded by the owner, so assets and owners equity changed, but liabilities stayed at zero.

This time the assets and liabilities changed, but not the equity. The owner’s stake in the assets of the business is unaffected (still $15,000). The owner now really owns only 75% of the assets ($15,000 / $20,000).

If you are having any difficulty with understanding the example above, return to the lesson entitled Define Liability.

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