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Long term liabilities.

Last month we discussed accounting for current liabilities, those obligations which were expected to be met within one year. The second chapter of the liability story concerns long-term liabilities, those that will not be satisfied within the year. Often found long-term liabilities are notes, bonds and mortgages payable, lease obligations, deferred income taxes payable, pensions and unearned revenues. Care must be taken to ensure that all long-term liabilities are recorded, since the existence, terms and kinds of long-term debt will determine how the readers of the financial statements evaluate the firm's ability to pay its current and possible future obligations. With careful attention given to long-term liabilities, the balance sheet will be a more valuable information source for all concerned.

A long-term note payable may be written in either an interest bearing or non-interest bearing form. Interest-bearing notes are recorded at face value. As payments are made on these notes, interest expense is recognized and the balance of the liability is reduced. We know that it is highly unlikely that a "rational business person" would lend money for free, and thus we assume that "non-interest-bearing" notes must include some interest in the face value! To record this type of note, the face value must be discounted to the present value. The discounted interest is shown as the contra-liability account called "Discount on Notes Payable," which is recognized as interest as periodic payments are made on the note.

Mortgages frequently arise for companies that wish to borrow money to buy land, build buildings or purchase major operating assets. Mortgages differ from notes payable in that the assets purchased are usually pledged as security against the debt. And, of course, they are usually larger debts! Mortgages involve periodic payments that include both principal and interest. Because the interest is in addition to the principal, mortgages are generally recorded at their face value.

Lease obligations must be reviewed carefully to determine whether the lease is an operating lease (in reality a short-term rental agreement) or a capital lease. Short-term leases are recognized as "rental expense" as payments are made, and thus do not appear on the balance sheet. A capital lease, however, is in effect a purchase and results in the recording of an asset (the item leased) and a long-term liability to the lessor. Interest is assumed to be included in the lease's face amount, and we must record the liability at the present value of the obligation. Interest will be recognized as lease payments are made.

Accounting for deferred income tax liability has been the subject of serious controversy for a number of years. FASB #96, postponed twice and now replaced with FASB #109, was to provide comparability of financial statements with regard to this area. Instead, the four-year span between them has caused inconsistency in the way many companies have reported this complex topic. With the 12/15/92 effective date for FASB #109, comparability should soon be more achievable, and practitioners should be spared the complexity that FASB #96 threatened. For more information on this long-term liability, refer to the June 1992 NPA Accounting Scene article.

Finally, a company's obligation to its pension plan can represent a major portion of long-term liabilities. FASB #87 requires that firms with a pension plan report a minimum pension liability that is at least equal to the unfunded accumulated benefit obligation. To calculate the unfunded ABO, one first determines the ABO, an estimate of the present value of future benefits based on current salary levels of those eligible for the plan. From this ABO is subtracted the fair market value of the pension plan assets. Clearly numerous audiences are interested in careful reporting of this obligation, including government bodies, unions, employees, potential investors or creditors and, of course, company management.

On page 8 are problems that deal with liabilities and their reporting. Try your hand at them! The answers will be printed in February.

Scenario for January Quiz

After reviewing Carvel's balance sheet, the loan officer for First National Bank decided that, due to the large amount of the loan request, the company's financial statements should be reviewed before the bank would approve the application. During the review, the following information was discovered.

1. No interest had been recorded on either the short-term or the long-term note payable. The short-term note is an 8% note that has been outstanding for 6 months, and 3 months' interest has accrued on the long-term note which bears interest at 10%.

2. Accrued wages totaling $2,000 should have been recorded at year-end. (Ignore any payroll taxes or withholdings.)

3. Sales Revenue account balance at year-end revealed a $3,600 payment from a customer for merchandise to be delivered in 1993.

4. No entry was made to record income taxes for 1992. The auditor determines that Carvel is subject to a 20% tax rate for 1992. The company had originally computed net income of $48,000, which was added to the Retained Earnings account balance.
January Quiz
I. Given the following amounts taken from the adjusted trial
balance of ABC Corp., prepare the liabilities section of the
balance sheet:
Accounts Payable $36,000
Property Taxes Payable 6,300
Short-term Notes Payable 44,000
Mortgage Payable (due within one year) 28,000
Mortgage Payable (due after one year) 300,000
Accrued Interest on Mortgage Payable 3,000
Lease Obligations (due within one year) 58,000
Lease Obligations (due after one year) 414,000
Rent Payable 70,000
Income Taxes Payable 50,000
Federal & State Unemployment Taxes Payable 16,000
Deferred Income Taxes Payable 105,000


Revise the balance sheet to reflect the newly discovered information. If you were the loan officer, would you approve the application?

Answers to December Quiz
The liabilities for Zworykin TV Repair are as follows:
Trade accounts payable $3,160.00
Notes payable 5,000.00
Property tax liability 4,620.00
Sales tax payable ($88.548 x .05) 4,427.00
FICA tax payable ($20,400 x .0765 x 2) 3,121.20
Federal unemployment tax payable ($14,000 x .008) 112.00
State unemployment tax payable ($14,000 x .054) 756.00
Federal income tax withholding 952.00
Total liabilities $22,148.20

Other liabilities may exist for which no documentation was provided. There may be bank loans, missing invoices or accrued liabilities. As an example, is Sophie's mom charging interest on the note? Tony should be questioned about these possibilities, and perhaps a conversation should be held with Tony's bank. Also, Tony may owe penalties arising from his failure to remit his taxes on a timely basis. State and federal officials should be contacted to determine if such penalties are forthcoming.

This is an ideal opportunity to assist Tony in basic accounting!
COPYRIGHT 1993 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

Article Details
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Title Annotation:Accounting Scene
Author:Winicur, Barbara
Publication:The National Public Accountant
Date:Jan 1, 1993
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