Updated July 19, 2023
Definition of Long Term Liabilities
The term long-term liabilities refer to those obligations of an entity that are expected to be settled after a period of twelve months from the reporting period. They are also known as non-current liabilities and shown as a separate heading in the Balance Sheet of an entity.
Explanation
A liability may consist of some portion that is to be paid within a period of twelve months and another portion that is to be paid after a period of twelve months. The portion that falls due for payment within a period of twelve months is classified as a current liability and the portion that falls due after a period of twelve months is classified as a long-term liability. Thus, long-term liability is the liability that has to be settled after twelve months. However, if the operating cycle of the entity is more than twelve months then such a longer period of operating cycle shall be considered instead of twelve months.
Examples of Long Term Liabilities
Below are some examples of long-term liabilities:
- Loans outstanding
- Lease rentals payable
- Bonds payable
- Deferred tax liability
- Post-retirement benefits payable
Types of Long Term Liabilities
There can be two types of long-term liabilities namely operating liabilities and financing liabilities.
- Operating Liabilities: Operating liabilities are the obligations that are created on account of the operating activities of the business. These include capital lease payments, employee benefit plans, deferred tax liability, and other expenses payable after a period of twelve months that have a nexus with the operating activities.
- Financing Liabilities: Financing liabilities are those obligations that arise from the financing activities of the business. These include bonds payable, loans payable, notes payable, and so on.
Uses of Long Term Liabilities
The main use of long-term liabilities is to evaluate financial ratios for the management of the entity. The most common ratios that are calculated using long-term liabilities include:
- Long-Term Debt Ratio: It is a solvency ratio that compares the level of long-term liabilities to the level of assets. It indicates the company’s ability to pay debts from its assets.
- Long-Term Debt to Equity Ratio: It reflects the extent to which business is funded through long-term liabilities as against equity funds i.e. it indicates the financing structure of the company.
Long Term Liabilities vs Long Term Debt
The following table explains the difference between long-term liabilities and long-term debt.
|
Basis of Difference |
Long Term Liabilities |
Long Term Debt |
| Meaning | It reflects to the amounts owed by the business to the outside parties that are payable after a period of twelve months. | It reflects the amounts of borrowings that are due for repayment to the outside parties by the business after a period of twelve months. |
| Basis of Creation | They are the financial obligations of a business that arise due to business activities being carried out, such as the purchase of assets, raising of finance, and so on. | They arise when the business borrows funds from the lenders that have to be paid at a future date. Long-term debt forms part of long-term liabilities itself. |
| Classification in the Balance Sheet | They are classified as a separate heading under the broad heading “Equity and Liabilities”. | They are classified within the heading of “Long-Term Liabilities” since they form part of the same. |
| Use | They can be used to analyze the long-term liquidity of the company. | They can be used to understand the debt levels of the company. |
Advantages of Long Term Liabilities
Some of the advantages is given below:
- The long-term liabilities help the users to understand the financial health of the company.
- It helps in the calculation of useful financial ratios whose analysis gives meaningful insights about the business.
- It can be compared with the level of equity so as to understand how well the company is using its own funds before taking outside debts.
- It can be used to calculate long term solvency so as to understand the ability of the company to pay its long-term liabilities.
Drawbacks of Long Term Liabilities
Some of the drawbacks are given below:
- They are to paid by the company in the future even if after a period of one year.
- Some long-term liabilities like debt are to be paid along with a high level of interest.
- A high level of long-term liabilities shows the company’s dependence on external funds.
Conclusion
The value of long-term liabilities is an important element of the balance sheet. It helps the investors to understand the financial strength of the company. The same is shown as an independent heading in the Balance Sheet as per internationally accepted accounting standards.
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