Long Term Liabilities

Introduction

Liabilities are obligations of a company that is payable within a certain time period. Depending on the nature and time period, liabilities are divided into three types.

They are –

• Current liabilities or short-term liabilities

• Long-term liabilities

• Contingent liabilities.

Current liabilities or short-term liabilities are payable within the same business cycle or the operating cycle of a business. Long-term liabilities are payable within a period of more than a year. Then, there are contingent liabilities that have not occurred yet and depend on certain events for getting started.

What are Long-Term Liabilities?

Long-term liabilities are important for businesses. They represent the amount borrowed as debt for investing in a new business project or buying capital assets. The ability to pay long-term debts determines the long-term solvency of a company.

Short-term and long-term liabilities show the current and future financial strength of a company.

While Long-term liabilities are debts or payable amounts of a firm the payment of which has to be made within more than a year. So, the companies have to prepare themselves for paying long-term liabilities by calculating the time period and the amount payable. Meanwhile, it must be noted that long-term liabilities need not be paid in the current accounting cycle of a business which is why these liabilities are also called noncurrent liabilities.

So, we can state that –

$$\mathrm{Long\:term\:liabilities\:=\:Total\:Liabilities\:−\:Current liabilities}$$

Differences between Long-term Liabilities and Short-term Liabilities

Long-term liabilities	Short-term liabilities
Long-term liabilities are payments that must be met within a period of more than a year.	Short-term liabilities are payable within a year.
Long-term liabilities show the solvency of a firm.	Short-term liability shows the liquidity status of a company.
Long-term liabilities show the overall strength of a company in meeting its financial needs over a longer period of time.	Short-term liabilities show the current strength or the ability to meet short- term needs.

Types of Long-term Liabilities

Long-term liabilities are of two types.

Financing Liabilities

Financial liabilities include -

• Convertible bonds that can be converted to common shares by bondholders.

• Bonds payable that are debts issued to the general public or investors.

• Notes Payable that are debtors issued to a single investor.

Operating Liabilities

This may include -

• Capital lease agreements for using factory, apartment, or equipment.

• Obligations such as post-retirement benefits to employees etc.

Examples of Long-term liabilities

A few examples of long-term liabilities are the following −

• Bonds Payable − A company may issue bonds to raise capital. These bonds carry interest and are payable after a certain period of time. Bonds are essentially debt instruments with payment terms of more than a year. The bonds usually pay interest up to a certain period and offer the principal amount back on the maturity of the bond at a later date.

• Leases Payable − Leases are payments that a company must pay for using an asset that is the property of another entity. In the case of a financial lease, the payments must be made only when there is a financial aspect associated with the lease. The lease payment is usually made in the future and the assets for which the lease must be paid are used in the present.

• Pensions Payable − If a company has any pension plan, it must pay its employees’ pension according to pre-set terms. Pensions are paid after retirement and so it is a long-term debt that must be paid in the future. Usually, pensions are a recurring amount but they can be paid at once as well.

• Loans Payable − Loans are amounts obtained from lenders that need to be paid at a later date by companies. These lenders include various banks and financial institutions. The loans usually have an interest attached that must be paid gradually and which is a current liability (must be paid in the current accounting cycle). After the maturity of the loan, the principal has to be returned to the lender which usually occurs beyond a period of one year, which is why it is called a long-term liability.

Long-term Liabilities based on Nature

Depending on the nature of liabilities, long-term liability is divided into the following four types:

Shareholders’ Capital

Companies usually fund their businesses using shareholders’ capital. This is known as seed funding. There are two types of shareholders, namely preference and equity shareholders. Preference shareholders must be paid dividends even in the case of a loss while equity shareholders get dividends only when there is a profit. Equity shareholders usually have voting rights that the preference shareholders don’t have. Shareholders get dividends based on their investment in the company. The risk-to-reward ratio is also fixed depending on the contribution of the shareholder.

Deferred Tax Liabilities

Companies may opt to skip paying full of the accumulated taxes and pay some amount of tax in the coming cycle of business. This deferment of taxes is called deferred tax and it is usually considered a long-term liability because the period of payment exceeds the current business cycle. However, businesses must pay a certain amount of taxes and cannot escape the entire tax that needs to be paid.

Long-term Borrowings

A company cannot just gather enough money from shareholders’ investments. It needs to borrow capital in the form of bonds or loans from financial institutions and lenders. Long-term borrowings have a repayment schedule after 12 months. Hence these are called long-term liabilities. There are two types of long-term borrowings.

• Long-term bonds or debentures are issued by companies to collect funds from the market. The bondholders only care about their interest and principal payment. They do not care whether a company is in loss or profit. The bondholders must be paid until a company is declared insolvent.

• Companies may also borrow funds from banks and financial institutions as loans for which they must pay a fixed or floating rate of interest. A fine or penalty may be charged when the payments of interests and principal are not made in time by the company.

Lon-term Provisions

Companies may set aside a portion of their funds for future bad debts or losses that may occur in the long term. This amount is treated as a loss even when the loss has not occurred yet.

Conclusion

Long-term liabilities are an important concern for businesses because they imply the financial health of a company in the long run. If a company can meet its long-term liabilities successfully, then there are enough chances that the company will be able to earn a profit in the future. Hence, long-term liabilities should be taken seriously by companies.

FAQs

Qns 1. What is the formula for getting long-term liabilities from total and current liabilities?

Ans.

$$\mathrm{Long\:term\:liabilities\:=\:Total\:Liabilities\:−\:Current liabilities}$$

Qns 2. Give three examples of long-term liabilities.

Ans. Bonds payable, Loans payable, and leases payable are three examples of long-term liabilities.