Accounting 101 Basics of Long-Term Liability

Long-term liabilities are a major source of capital financing.

In reference to accounting, liabilities are the claims against a business' assets. Long-term liabilities, also referred to as noncurrent liabilities, are those with a maturity period of more than one year. Consequently, these liabilities can remain due for a period of more than 10 years. Examples of long-term liabilities include long-term loans, notes payable, bonds payable and mortgage payable. International accounting standards (IAS) and the generally accepted accounting principles (GAAPS) guides accounting for long-term liabilities.

Classification

Long-term liabilities fall under two broad classifications, financing liabilities and operating liabilities. The later are obligations created in the ordinary course of business and not with the sole intention to raise cash for the company. Examples include capital lease engagements and accrued expenses due after a period of one year. Financial liabilities however arise from debts that the company incurs to raise cash. Examples include notes payable and bonds payable. The basic recording and presentation of both classes in financial statements are similar.

Recording

The first step in recording is to prepare source documents affecting long-term liabilities transactions and then make the relevant journal entries. Posting is by crediting long-term liabilities in the relevant ledger accounts. Closing of accounts at the end of the accounting period yields the final balance of long-term liabilities. The balance carried down is the figure recorded in the trial balance and eventually the balance sheet.

Balance Sheet Presentation

The balance sheet equation stipulates that the total assets of a firm must be equal to the total financing of the firm. Capital and long-term liabilities form part of the ''Financed By'' section of the balance sheet, thus completing the accounting equation. When a company acquires long-term loans, it debits the par value of the loan received in the ''Assets'' section of the balance sheet as either cash or bank. In line with the double entry principle, credit the long-term liabilities section of the balance sheet.

Income Statement Presentation

Apart from the initial par value of the amount loaned, holders of long-term liabilities pay interest on the par value on a periodical basis. The interest charged on long-term liabilities forms part of the operating/financing expenditure of the firm. Offset interest expense against the gross profits in the income statement. The amount recorded as interest expense depends on the coupon rate agreed upon in the debt covenant.

References

• "Business Accounting 1"; Frank Wood; 2008
• "Financial Accounting"; A. R Jennings; 2006
• "Principles of Financial Accounting"; Paul D Kimmel; 2007