Examples of Long-Term Liability
Long-Term Liabilities refers to those liabilities or the financial obligations of the company which payable by the company after the period of next one year and the examples of which include long term portion of the bonds payable, deferred revenue, long term loans, long term portion of the deposits, deferred tax liabilities, etc.
Consider the example of the American retail giant Walmart Inc. in the balance sheet excerpt above. The Long term liabilities include long term debtLong Term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability., long term capital leaseCapital LeaseA capital lease is a legal agreement of any business equipment or property equivalent or sale of an asset by one party (lesser) to another (lessee). The lesser agrees to transfer the ownership rights to the lessee once the lease period is completed, and it is generally non-cancellable and long-term in nature., and financial obligations and deferred income taxes.
Most Common examples of long-term liabilitiesLong-term LiabilitiesLong Term Liabilities, also known as Non-Current Liabilities, refer to a Company’s financial obligations that are due for over a year (from its operating cycle or the Balance Sheet Date). include
- Long-term debt
- Finance leases
- Deferred tax liabilities
- Pension liabilities.
We will discuss each of the examples of long term liability along with additional comments as needed.
Most Common Examples of Long-Term Liabilities
Example #1 – Long-Term Debt
Apart from the simpler concept of bank loans, long term debt also includes bonds, debentures, and notes payableNotes PayableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. . These may be issued by corporates, special purpose vehiclesSpecial Purpose VehiclesA Special Purpose Vehicle (SPV) is a separate legal entity created by a company for a single, well-defined, and specific lawful purpose. It also serves as the main parent company's bankruptcy-remote and has its own assets and liabilities. (SPVs), and governments. Some bonds/debentures may also be convertible to equity shares, fully or partially. The terms of such conversion shall be specified at the time of the issue.
Long-term debt may be either secured i.e., backed by collateral or unsecured.
- Bonds are typically secured i.e., backed by specific collateral assets.
- Debentures are not secured by any collateral and are generally issued for specific purposes, such as planned projects. It is generally the revenue proceeds from the specific project that is later used to repay the debenture principal. Without any collateral backing, these instruments generally have higher credit risk than bonds and other secured debt. It makes it essential to appropriately assess the financial strength and creditworthiness of the issuer. Debentures are generally issued with a longer time to maturity and at lower interest rates as compared to other types of debt.
- Notes are the same as bonds in most cases. However, their prominently distinguishable feature is the shorter maturity of treasury issues—the U.S. Treasury, for example, issues notes with maturities of 2, 3, 5, 7, and 10 years, while bonds are issued for longer terms as well.
Example #2 – Finance Lease
A lease contract is termed as a finance lease, also known as a capital lease if it fulfills any of the following capital lease criteriaCapital Lease CriteriaCapital lease criteria includes the following 1) transfer of ownership to lessee 2) option to purchase the leased asset at the price below the market price 3) lease period is at least 75% of the assets economic life 4) minimum lease payment’s present value must be at least 90% of the asset’s fair value.:
- At the end of the lease period, ownership of the leased asset is transferred to the lessee.
- The term of the lease is at least 75% of the asset’s useful life.
- The present value of lease paymentsLease PaymentsLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration. is at least 90% of the asset’s market value.
- The contract allows the lessee to purchase the asset at a bargain i.e., lower than market value.
For lease contracts of over one year, the lessee records a long-term liability equaling the present value of lease obligations. A fixed asset of equivalent value is also recorded in the lessee’s balance sheet.
Example #3 – Deferred Tax Liability
Owing to the difference between accounting rules and tax laws, the pre-tax earnings on a company’s income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements. may be greater than the taxable income on its tax return. It is because accounting is done on an accrual basis, whereas tax computation is on a cash basis of accounting. Such a difference leads to the creation of deferred tax liability on the company’s balance sheet.
Deferred tax liabilities are thus temporary differential amounts that the company expects to pay to tax authorities in the future. At a later date, when such tax is due for payment, the deferred tax liability is reduced by the amount of income tax expense realized. The cash account is also reduced accordingly.
Example #4 – Pension Liabilities
Pension obligations give rise to liabilities in case of defined benefit plans only, where the employer (company) promises to pay a specific amount to retired employees, based on their salaries, period of service, etc.
- The employer sets aside funds for this purpose by investing in the pension plan/trust, generally referred to as plan assets. The present value of the pension obligation is referred to as the Projected Benefit Obligation (PBO).
- When PBO exceeds the fair value of plan assets, the plan is said to be ‘underfunded,’ and such excess amount is recorded as a pension liability in the employer’s balance sheet.
- Pension liabilities are thus sensitive to several factors, such as the performance of the underlying plan assets, an increase in salaries, the discount rate used in the calculation of PBO, life expectancy, and other actuarial assumptions.
Consider the example of American pharmaceutical company Pfizer Inc. It contains Pension liabilities, in addition to debt and deferred taxes. Pfizer’s commitments under a capital lease are not significant (as mentioned in the annual report) and are thus not described separately here.
The pension liability is further detailed in the notes section (excerpt below).
Source: Pfizer Inc Filings
Different sources of funding are available to companies, of which long-term liabilities form an important portion. We often come across some or all of the types described above in balance sheetsBalance SheetsA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. across industries. These are usually looked into as an integral part of financial analysis, especially for financial leverage and credit risk assessment.
It is also essential to understand the computation of such liabilities, their payment schedules, and any additional terms associated with each of them. Such details are available in the notes to accounts in annual reportsAnnual ReportsAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company's performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements..
This article has been a guide to Long-Term Liabilities Examples. Here we discuss the top 4 Examples of Long-Term Liabilities, including Long-term Debt, Financial Lease, etc. Here are the other articles in accounting that you may like –