A long-term liability is an obligation by a business or organization to repay funds borrowed. The repayment of that obligation is spread over more than one year (operating cycle). Examples of long-term liabilities are mortgages, bonds payable, and vehicle loans. Long-term liability accounts have a normal credit balance. They increase on the credit side and decrease on the debit side. Long-term liabilities are often called long-term debt.
What is the Difference Between a Long-term Liability and a Current (Short-term) Liability?
A long-term liability has a repayment schedule that has payments due more than one year in the future. A current liability is paid within one year.
For more knowledge about Current Liabilities, watch this video:
What are some Examples of Long-term Liabilities?
Long-term liabilities include:
|Mortgage Payable||Pension Liabilities|
|Notes Payable||Deferred Tax Liabilities|
|Bonds Payable||Capital Leases|
|Customer Deposits (if carried into future years)||Deferred Compensation|
|Deferred Revenue (if carried into future years)||Post-retirement Healthcare Liabilities|
Accounting for Long-term Liabilities
When a company or organization takes on a new liability, it needs to be entered as a liability. Some typical transactions for accounting for Long-term Liabilities are listed below.
Adding a New Long-term Liabilities to the Books
Purchase of an Asset: a company purchases a vehicle (Fixed Asset) for $40,000, financing $30,000 for 5 years at an interest rate of 5%, and paying the remaining $10,000 in cash. The journal entry to record the new asset, new loan, and reduction in cash is:
Issuing a Bond: a company issues a bond for $200,000 at face value. (For more information about bonds, read this article: https://accountinghowto.com/bonds-payable.) The journal entry to record the new liability and the increase in cash is:
Making payments of a Long-term Liability
When a company or organization takes on debt, each debt has its own payment schedule and interest rate. When a payment is made, the principal (a portion of the loan amount) is tracked separately from the interest portion of the loan.
As an example, let’s say the vehicle loan had monthly payments of $500 including $50 of interest. The journal entry to record the payment is:
Most loans are set up for more interest to be paid in the early years of a loan, with decreasing interest amounts as the loan progresses. This interest payment structure is detailed in an amortization schedule.
What is an Amortization Schedule?
An amortization schedule breaks the payments on a loan into principal payments and interest payments.
Here is a sample amortization schedule for the Vehicle loan:
The amortization schedule shows the decreasing amount of interest as each payment is made, and the decrease in the principal balance. In the 60th month of the loan (5 years x 12 payments), the principal balance reaches zero and the loan is paid in full.
Using the amortizations schedule, principal and interest payments can be easily tracked and recorded each time a payment on the loan is due.
For the first payment due, the journal entry to record the principal and interest is:
For businesses required to follow Generally Accepted Accounting Principles (GAAP), an additional calculation is needed to separate the portion of long-term debt due in the next twelve months (operating cycle.) This portion of long-term debt is classed as a current liability rather than a long-term liability.
What is Current Portion of Long-term Debt?
Current Portion of Long-term Debt is the amount of principal due on liabilities in the next twelve months. It is separated out from the full amount of long-term liabilities to help a business understand the amount of debt payments due in the near future.
For example, if total long-term liabilities equals $20,000 and of that, $5,000 is due in the next year’s time, this debt is considered to be a Current Liability. For a deeper understanding of Current Portion of Long-term Debt, watch this video: