What are Long Term Liabilities
Liability is referred to as a present obligation of a business that will be payable in future. These are debts or legal obligations that a company owes to a person or company.
Liabilities are classified into three main types
1. Current Liabilities which is also known as short term liabilities.
2. Non-current liabilities which are also known as long term liabilities.
3. Contingent liabilities
Short term liabilities are due within a year whereas long term liabilities are due after one year or more than that. Contingent liabilities are liabilities that have not yet occurred and are dependent on a certain event for being triggered. Classifying liabilities into short and long term is necessary as it helps users of the accounting information to determine the short term and long term financial strength of a business. Short term liabilities show the liquidity position while long term liabilities show the solvency of the company in the long term.
Let’s discuss long term liabilities in detail.
Long term liabilities are also called non-current liabilities which are obligations or debts of an organisation or a business that is due in over a year’s time or in other words, these are liabilities that need not be payable in the current accounting period.
Long-term liabilities = liabilities – current liabilities
Long term liabilities form an important component of an organization’s long term financing plans. Companies or businesses need long term debt in order to be used for purchasing of capital assets or for investing in any new business project.
Long-term solvency of a company is determined by its ability to pay the long-term liabilities.
Some examples of the long-time liabilities are:
- Bonds payable
- Leases payable
- Pension payable
- Loans payable
The above-mentioned examples will be described in brief in the following lines
can raise money in the form of issuing of shares or through issuing of debt which needs repayment along with interest. Bonds payable are debt instruments that are obligations for the company and which need to be repaid at a later date.
Leases payable is about the current value of lease payments that should be made by the company in future for using the asset. This is recognised only on the condition that the lease is recognised as finance lease.
This kind of liabilities arise when the company has a pension plan. This is regarded as the amount that the company shall be paying to the employees in future as compensation.
Loans are obtained from banks or any other company. The rate of interest in loans can vary from fixed or variable which the company that has borrowed needs to pay over the complete term of the loan. The loan principal is a loan amount that is repaid either at the end or over the total period of the loan.
Also, based on the nature of liabilities that are taken by a company, the long time liabilities list will include the following items:
- Shareholder’s capital
- Deferred Tax Liabilities
- Long term borrowings
- Long term provision
Let us know these items in detail
Shareholders are the real owners of an organisation. They are of two types namely, preference shareholders and equity shareholders. Preference shareholders have the preference when profits are shared in the form of dividends. They receive dividends even in instances of loss. Equity shareholders will be receiving dividends only when a company is earning profit. Another point of difference is that equity shareholders are having voting rights whereas preference shareholders do not have. The company receives its initial funding which is also known as seed funding from the shareholders. Each shareholder is given a certain amount based on their contribution towards the capital. Also, the risk-to-rewards ratio is distributed as per the contribution towards the capital.
Deferred Tax Liabilities:
These are tax liabilities of a business which it needs to pay in case the business earns profit. It is called deferred tax liability since a company can opt to pay for less tax in a financial year but it has to repay the balance in the next financial year. Tax that is not paid in full is a liability for the company and is treated as deferred liabilities.
Long Term Borrowings:
Borrowing is an essential part of business. A company cannot raise all its funds only from the shareholders capital. A company that has a high fund requirement needs to take loan from banks or financial institutions which is repayable along with interest. Long term borrowings are the types of loan that will be repayable after 12 months. The following are types of long-term borrowings:
a. Bonds or Debentures have a debt or loan that is borrowed from the market at a fixed rate of interest. Bond holders are only concerned with the repayment of interest, they are not at all concerned with the company profits or loss. Bondholders are bound to be paid till the company is declared as insolvent.
b. Apart from bonds, a company can borrow from banks or financial institutions which will be regarded as a loan having a repayment tenure and fixed or floating rate of interest. The company can face penalty if the loan repayment is not done within the time period.
Long Term provision:
The act of provisioning is related to the setting aside of an expense or loss or any bad debt in future by the company. The item is treated as a loss before it is being actually accounted for as a loss by the company.
Types of Long-Term Liabilities
Long term liabilities can be of two types:
1. Operating Liabilities: Operating liabilities include capital lease obligations which can be rent for using the plant, property and the equipment or obligations such as postretirement benefits or expenses that are incurred which can include pending lawsuits or deferred income taxes.
2. Financing Liabilities: Financing liabilities include bonds payable which are debts issued to investors or general public, notes payable which are debts being issued to a single investor and convertible bonds which are debts that have the provision to be converted by bond holders for common shares.
This was all about the long-term liabilities which are an essential part of long term financing for an organisation. For more interesting Commerce concepts, stay tuned to BYJU’S.