Current liabilities are expected to be paid during the fiscal year, but how are non-current liabilities accounted for? We’ll look at the definition of non-current liabilities in more detail below, as well as the many types and examples of financial commitments that may fall into this category.
What are Non-current Liabilities?
Non-current liabilities are significant enough to warrant their own item on the firm balance sheet, but what precisely are they? Non-current liabilities are defined as any debts or other financial commitments that are repayable after a year. Pension benefits, long-term property rentals, and deferred tax payments are all typical examples.
A company’s ability to meet long-term financial obligations can be assessed by comparing non-current liabilities to cash flow. A company may manage a greater debt load in the long run if its cash flows are stable. It’s also critical to keep track of these long-term liabilities so that you can plan ahead for future investments and asset acquisitions.
Non-Current Liabilities Examples
The examples that follow are as follows:
Example #1 – Payable Long-Term Loans
Last year, Company XYZ increased its operations. The enlargement was anticipated to cost $500,000. The company’s sales increased as a result of the growth process. Prior to the expansion, the corporation was not particularly profitable. Company XYZ obtained a long-term loan from the State Bank and agreed to repay $700,000 after 5 years. As a result, the responsibility is to pay down $700,000 after 5 years. Because one year has already passed, the loan payment will be due in four years. The loan amount will be recorded as a long-term loan in the Non-Current Liability section of the company.
Example #2 – Issuance of Long-Term Bonds
Petrochad is an oil exploration and production firm. Oil drilling setup necessitates a large capital expenditure in order to extract oil, transport it, and so on. Market-traded bonds are frequently used to meet capital requirements. Bonds are legal contracts in which the issuer agrees to pay a set sum of money at a later period in exchange for a current price. Assume that the corporation petrochad issued ten-year long-term bonds. The bond has a face value of $1,000,000. So, at the conclusion of the tenth year, Petrochad must raise $1,000,000 to pay off the bonds. As a result, the responsibility is fixed but not current. Petrochad will include the liability in the Non-Current Liability section of its balance sheet.
Example #3 – Pension Obligation with Defined Benefits
Edward is the CEO of a medium-sized private company with 500 employees. The corporation uses a defined benefit pension plan. Employees will be paid a fixed pension after retirement for the remainder of their life under this system. The fixed pension amount will be determined by the last pay drawn at the time of retirement. As a result, the company’s defined benefit pension plan is a liability. When the employees begin to retire, the liability will be triggered. The actual pension liabilities that are reflected in the books today is the present value of the future liability. Because this is not a current liability, it is recorded in the Non-Current Segment.
Example #4 – Life Insurance Purchased
ABC Ltd is an insurance company. They offer insurance for things like life, homes, and autos. When the protection buyer dies, life insurance pays out a lump sum of money. As a result, the corporation must pay any claims that may arise as a result of death. The average life expectancy differs from one country to the next. The liability that may arise as a result of death is a hypothetical event. This is an example of Non-Current liability, which occurs in the future. ABC Ltd will estimate the likely insurance claims and display them under the non-current segment of the Liability side.
Example #5 Deferred Tax Liability
When the tax estimated by the tax authority differs from the tax calculated by the company, this is referred to as a deferred tax. PFG is a manufacturing company that hired an accounting firm to compute the company’s taxes. The accounting company computed the tax amount in accordance with accounting norms. The tax amount determined by the tax authority differed from the tax amount calculated by the accounting company. Deferred Tax Liability results from the discrepancy. If the liability is not paid within 12 years, the disparity will gradually reverse. As a result, because the liability is long-term, the amount will be reflected on the Non-Current side of the Liability.
Non-Current Liabilities Key Financial Ratios
Investors, creditors, and financial analysts use numerous financial ratios to assess a company’s non-current liabilities in order to identify its leverage and liquidity risk. Some of the ratios are as follows:
#1. Debt-to-income ratio
To evaluate a company’s level of leverage, the debt ratio compares total debt to total assets. It represents the percentage of the company’s capital that is financed with borrowed funds. The smaller the percentage, the lower the company’s leverage and the stronger its equity position.
A high proportion indicates that the company has a significant level of leverage, which increases the chance of default. Debt to total asset ratio of 1.0 indicates that the company has a negative net value and is more likely to default.
#2. Ratio of Interest Coverage
The interest coverage ratio is used to determine if a corporation generates enough income to cover its interest payments. The ratio is calculated by dividing earnings before interest and taxes (EBIT) by interest expense incurred in a particular period. A greater coverage ratio indicates that the company can comfortably handle interest payments and incur extra debt.
Types of Non-Current Liabilities
The following are the most common types of non-current liabilities found on a balance sheet:
#1. Credit Line
A credit line is an agreement between a lender and a borrower in which the lender makes a set amount of funds accessible for the borrower’s business when needed. Instead of receiving a flat sum of credit, the company obtains a particular quantity of credit as needed, up to the credit limit set by the lender.
A credit line is typically good for a set length of time during which the business can draw funds. If a company borrows money to buy industrial equipment, the credit is regarded as a non-current liability.
#2. Long-term rental agreement
Lease payments are frequent expenses that businesses must incur in order to fulfil their purchase agreements. Capital leases are used by businesses to finance the purchase of fixed assets such as industrial equipment and automobiles.
If the lease period is more than one year, the lease payments paid towards the capital lease are classified as non-current liabilities because they lower the lease’s long-term obligations. The capital lease-purchase property is recognized as an asset on the balance sheet.
#3. Bonds to be paid
A bond is a long-term financial agreement between a lender and a borrower that is used to fund capital projects. Bonds are issued through an investment bank, and if the payment period exceeds one year, they are regarded as long-term liabilities. The borrower must make fixed-amount interest payments over a certain length of time, usually more than a year.
#4. Payable notes
A note, often known as a promissory note, is a sort of loan agreement in which the borrower unconditionally promises to repay the principal plus interest to the lender. The promissory note is a type of loan that is used to fund the purchase of assets such as machinery and buildings. If the note’s maturity time exceeds one year, it is classified as a non-current asset.
#5. Deferred Tax liabilities
Deferred tax liabilities are the taxes that a firm has not paid in the current period but that must be paid in the future. The liability is computed by subtracting the accrued tax from the taxes payable. As a result of a transaction that happened during the current period for which tax was not remitted, the corporation will be compelled to pay additional tax in the future.
Non-current liabilities Records In Balance Sheet
Here are three methods that can assist you in reporting non-current obligations on your balance sheet:
#1. Determine how you will organize your balance sheet.
The first step in keeping track of your long-term obligations is deciding how to identify your categories. There are two approaches you can take. The first format option is to organize liabilities by each client. Using this method, you can determine how much someone owes as a percentage of the entire liability amount. The second method is to arrange the balance sheet by the sort of non-current liabilities owing to you and then sum them all.
#2. Enter the amounts for non-current payments.
After you’ve completed your balance sheet, make a note of the total amount owed for each sort of long-term debt. Check each quantity, as well as your computations, to ensure you haven’t entered the wrong figure. Also, make certain that the correct amount is associated with the relevant debt category. This allows you to avoid inaccuracies that could endanger your decision-making and collecting operations. Check your sums against the payment documentation you have on file, or seek verification from a liability or accounting specialist.
#3. Compile your totals
After you’ve entered the payments and confirmed that your totals are correct, compute the total of all non-current obligations. You can find the total by hand or use a simple sum formula that does the math for you. As with the debt numbers, make sure the total value for your yearly liabilities is correct.
Non-current Liabilities Importance in Accounting
When evaluating a company’s financial health, both current and non-current liabilities are useful. However, there are specific advantages to scrutinizing non-current liabilities in accounting. Long-term liabilities, for example, can assist you to determine whether a new venture makes sense for your company. If your cash flow is insufficient to cover future commitments, now might not be the best moment to take on new financial obligations.
When looking at financial ratios, business owners, creditors, and investors all employ non-current liabilities. Debt ratios, interest coverage ratios, and debt-to-equity ratios are a few examples. These provide a rapid snapshot of liquidity by comparing liabilities to assets or equity.
Other Types of Liabilities
In addition to non-current liabilities, there are two other types: current liabilities and contingent liabilities.
#1. Current liabilities
Current liabilities are the obligations and short-term payments owed to suppliers by a corporation within a year. Following are some examples:
#2. Accounts payable:
This is a short-term obligation that a corporation must pay to a creditor or supplier in exchange for their products, supplies, or services.
#3. Income taxes payable:
These are the taxes that a company must pay to the government in a particular fiscal year. This estimate differs based on the state and city of the company.
#4. Bills payable:
This is a distinct obligation that refers to a short-term loan from one bank to another.
#5. Interest payable:
This is the amount of credit used by a corporation to finance a short-term transaction, plus the interest that accrues.
#6. Wages payable:
This is the amount of money an employee has earned but hasn’t yet received. This is typical because most businesses pay their staff twice a month.
#7. Dividends payable:
The stock that corporations issue to investors and the amount they owe to their shareholders after declaring a dividend are both referred to as dividends payable. This type of liability typically occurs four times per year until the dividend is fully paid.
#8. Unearned revenues:
This is a company’s obligation to provide a product or service shortly after receiving an advance payment from a customer or client.
#9. Discontinued operations liabilities:
This refers to the financial impact of a sold or discontinued product, department, or operation.
#10. Overdrafts on bank accounts:
This occurs when you overdraft your account and then incur a fee for each day your account remains in overdraft.
#11. Short-term loans:
These are short-term loans that demand the borrower to repay the principal amount plus interest by the due date.
Contigent Liabilities
Contingent liabilities are financial responsibilities that may arise as a result of a future occurrence, such as a lawsuit. Here are several examples:
#1. Product warranties:
This is a guarantee provided by a firm to customers in the event that a purchased product malfunctions or fails to perform as expected within a certain duration.
#2. Lawsuits:
When a customer files a legal claim against a firm for payment because a product or service caused them physical or emotional suffering, this is referred to as a lawsuit.
#3. Recalls:
If a firm recalls one of its products, it may be required to reimburse customers or replace the recalled item.
In conclusion
While lenders are more concerned with current liabilities, non-current liabilities are frequently used by investors to assess risk. If a company spends the majority of its core resources only to meet its financial responsibilities, investors will be apprehensive because it means there won’t be any leftover for expansion. Keep track of all types of liabilities to stay on top of your financial commitments.
