The FASB has defined liabilities as "probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events." This definition contains significant components that need to be explained before individual liability accounts are discussed. A liability is a result of past transactions or events. Thus, a liability is not recognized until incurred. This part of the definition excludes contractual obligations from an exchange of promises if performance by both parties is still in the future. Such contracts are referred to as executory contracts.

Determining when an executory contract qualifies as a liability is not always easy. For example, the signing of a labor contract that obligates both the employer and the employee does not give rise to a liability in current accounting practice, nor does the placing of an order for the purchase of merchandise. However, under some conditions, the signing of a lease is recognized as an event that requires the current recognition of a liability even though a lease is essentially an executory contract. A liability must involve a probable future transfer of assets or services. Although liabilities result from past transactions or events, an obligation may be contingent upon the occurrence of another event sometime in the future. When occurrence of the future event seems probable, the obligation is defined as a liability.

Although the majority of liabilities are satisfied by payment of cash, some obligations are satisfied by transferring other types of assets or by providing services. For example, revenue received in advance requires recognition of an obligation to provide goods or services in the future. Usually, the time of payment is specified by a debt instrument, for example, a note requiring payment of interest and principal on a given date or series of dates. Some obligations, however, require the transfer of assets or services over a period of time, but the exact dates cannot be determined when the liability is incurred, for example, obligations to provide parts or service under a warranty agreement.

A liability is the obligation of a particular entity, that is, the entity that has the responsibility to transfer assets or provide services. As long as the payment or transfer is probable, it is not necessary that the entity to which the obligation is owed be identified. Thus, a warranty to make any repairs necessary to an item sold by an entity is an obligation of that entity even though it is not certain which customers will receive benefits. Generally, the obligation rests on a foundation of legal rights and duties. However, obligations created, inferred, or construed from the facts of a particular situation may also be recognized as liabilities. For example, if a company regularly pays vacation pay or year-end bonuses, accrual of these items as a liability is warranted even though no legal agreement exists to make these payments.