Long term liabilities are obligations that are due one year or longer after the end of the period. Since the time value of money can be large, long term liabilities are often valued at their present value, where current liabilities are at nominal value.
There are two basic rules that are important when dealing with liabilities that are at present value. First, by the passing of time the liability grows, which is an interest expense. Second, liabilities are reduced when money is paid.
Long-Term Liabilities Example
At the beginning of the year, the firm has loan of 10,000. The interest rate is 5%. At the end of the year, 500 interest is paid.
The journal entry of the interest expense:
Then, the firm decides to sell a machine and use the proceeds of 4,000 to partially pay down the loan.
The journal entry of this payment:
Long-Term Liability Explained
– long term liabilities are (normally) valued at present value
– when a liability is interest-bearing, the passing in time will result in interest expenses
– when money is paid (or products delivered/services rendered), the liability is reduced