Long-term liabilities include any future commitment of resources that are expected to be due in one year or longer. Long-term liabilities come in many forms, including notes, loans, debentures, pensions, bonds, and deferred tax liabilities. Two of the most common types of long-term liabilities are notes payable and bonds payable. Interest on notes payable, as well as amortization of premiums and discounts on bonds, including determining the present value and comparing the market rate of interest to any periodic payments made, all rely on the concept of the time value of money. These items must be reported in the notes to the financial statements.
At A Glance
Corporations require capital in order to conduct daily operations and set the stage for successful future operations. Corporations have short-term resource needs, such as enough operating cash to cover current payroll, as well as long-term needs.
Time value of money is the idea that money possessed today is worth more than the same dollar amount received in the future. All borrowers and lenders are impacted by the time value of money.
- The present value of a single amount can be derived if future value (FV) is known, the interest rate is stated in annual terms (r), and the number of periods to which the rate will apply (n) is known. As present values are always less than the future value, this is called discounting to the present value.
- The future value of a single amount can be derived if present value (PV) is known, the interest rate is known (r), and the number of periods to which the rate will apply (n) is known. As money we have today can be invested to generate a return, we refer to this as compounding or growing across time.
- An annuity is a financial arrangement that pays out a fixed payment stream over a set period of time. Both the present and future value of annuities can be calculated.
Bonds payable are similar to notes payable in that both are long-term liabilities. Bonds payable usually have a larger pool of investors, whereas notes payable are owned by a smaller group.
Bonds are priced at their net present value, taking into account the value of the bond itself at maturity as well as any payments associated with periodic interest payments based on the stated rate.
- Bonds with a stated interest rate lower than market normally sell at a discount. The discount must be spread across the life of the bond using amortization entries.
- Bonds with a stated interest rate higher than market normally sell at a premium. The premium must be spread across the life of the bond using amortization entries.
- Selling the bonds in line with a market rate of interest yields no discount or premium.
- The interest amortization method takes into account the purchase price of the bond, often used with discounts.
Installment notes are long-term liabilities that carry interest costs and must be paid back at specific points in time, typically in equal payments.
Long-term liabilities, such as bonds and notes, are expected to come due in one year or longer. Notes payable are broken down and reported as both current and long-term. As liabilities come due, they may shift from one classification to another.