What is the classification of severance pay in financial reporting?

Severance pay is classified as a current liability in financial reporting because it represents an obligation that a company has to pay to employees who have been terminated. This liability arises when employees become entitled to severance benefits, typically due to layoffs or restructuring. The payment is expected to be settled within a relatively short period, usually within the next 12 months, making its classification as a current liability appropriate.

Recognizing severance pay as a liability reflects the company’s responsibility to discharge these payments in the near future. This classification aids stakeholders in understanding the company's short-term financial obligations and liquidity position, providing a clearer picture of its financial health in relation to its upcoming liabilities.

Long-term assets are resources expected to provide future economic benefits over a period longer than one year, which does not apply to severance pay. Equity represents ownership interest in the company and is unrelated to employment termination benefits. Contra liabilities are accounts that offset or reduce a liability account, which is also not applicable to severance pay.