An Introduction to Non-Current Liabilities
In a company’s balance sheet, there are certain obligations that would become paid after a period of twelve months. These obligations are non-current liabilities, which are also known as long-term liabilities.
Non-current liabilities are closely matched with cash flow to determine whether a firm will be able to meet long-term financial obligations. Investors assess non-current liabilities to understand whether the company may be employing excessive leverage.
Different ratios are used for assessing non-current liabilities; these include debt-to-capital ratio and debt-to-assets ratio.
Characteristics of Non-Current Liabilities
The main features of non-current liabilities are –
There is a past or current liability which puts a firm under obligation
Liabilities are in the form of borrowing
When such an obligation is settled, it will lead to a decrease in a firm's assets
Non-Current Liabilities Examples
Examples of non-current liabilities are mentioned in the following section –
Long-term financial liabilities will fall under this category. It may arise from bond payable or bank loans which may be recorded in the balance sheet in the form of amortized cost.
Deferred tax liability qualifies as a non-current liability. A firm may use a straight-line method of depreciation for financial reporting. Such liability is created when gains or revenue are reflected on the income statement as it becomes eligible to be taxed.
Do You Know?
There is a particular order of listing liabilities in a company's balance sheet. Mainly, there are two categories of current liabilities and non-current liabilities. Within current liabilities, the items would include – current portions of long-term debt, short-term notes payable, payroll liabilities, accounts payable, income tax payable, and other accrued expenses.
However, the order may vary in different companies. For instance, accounts payable may feature as the first item in a liability account.
Non-Current Liabilities List
The list of non-current liabilities are as under –
1. Long Term Loans
Loans that a firm will have to pay over a longer duration (which is likely to be more than one year) are considered to be long-term loans. Such loans are backed by securities and extended by conventional banking or financial institutions.
Companies having high creditworthiness may avail such loans at a lower rate of interest. This loan obligation will fall under non-current liabilities in the balance sheet of a company.
2. Debentures
Debentures are the most prominent example of non-current liabilities. It is primarily a form of long-term debt instrument. Firms offer these in the absence of any asset backing. It is supported by the reputation and creditworthiness of an organization.
Larger companies offer debentures with the purpose of securing funding. It amounts to non-current liabilities for a company, given that investors will be paid in due time, and not particularly within one year.
3. Deferred Tax Liabilities
The non-current liability of deferred tax is owed to the tax department by a company. The liability arises since there exists a difference between the time that the tax has to be paid and when it is collected.
These liabilities indicated in the company's balance sheet give a future tax forecast for a firm. Settlement of the liabilities will cause a reduction in its net profit.
4. Bonds Payable
There is a higher degree of similarity between debentures and bonds payable. The point of difference is that bonds are supported by collateral or physical assets.
Bonds payable are categorized as non-current liabilities as it possesses the nature of the long-term debt. It is issued by a firm to secure funding for itself. Investors take into account the assets supporting the bond. A firm will have to pay investors at a future specified date.
5. Long Term Lease Obligations
Long-term lease obligations are payable after one year. Capital leases may fall under such obligations. Such arrangements are recorded under non-current liabilities in the balance sheet of a company, giving it an extended period for payment.
Companies are likely to pay for such leases in case of equipment, plant, and similar assets. The payment for rentals can be made after a considerable time.
6. Product Warranties
Product warranties extended by a company is an obligation that it has to meet if claims arise. Warranties may span across years, and in case of defects, the company may have to pay an aggrieved customer after a certain period. It is due to such deferred payment systems that product warranties are listed under non-current liabilities.
Such liability is likely to be reported as costs for repair or replacement of the product. However, the obligation of such payment will only arise if a claim is made within the period of warranty.
7. Pension Benefit Obligations
The obligations of paying pension benefits to employees take effect after a considerable time. It has to be paid to employees only after retirement. The pension amount is accumulated till the point of retirement, the duration of which spans across years.
These obligations are included within long-term liabilities, and a company will not have to pay them within twelve months.
8. Other Non-Current Liabilities
Other non-current liabilities will consist of any such items that cannot be classified under the categories mentioned above. The specifications of such liabilities are recorded as noted in the financial statements of a company.
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Examples of Non-Current Liabilities
Long-term loans, long-term leasing, debentures, bonds payable, deferred tax liabilities, obligations, and pension benefit payments are examples of noncurrent liabilities. The amount of a bond obligation that will not be paid within the following year is referred to as a noncurrent debt. Noncurrent liabilities include warranties with a term of more than a year. Deferred salary, deferred income, and some healthcare obligations are among more examples. Long-term debts include mortgages, auto payments, and other loans for machinery, equipment, or land, with the exception of payments due in the next twelve months, which are categorized as the current component of long-term debt.
Importance of Non-Current Liabilities
Non-current liabilities are used to assess a venture's solvency and to determine whether or not a firm is effectively leveraging it.
It is used to evaluate the cash flow stability of a business. By comparing total non-current liabilities to cash flow, one may easily determine a company's financial ability to satisfy long-term obligations.
A good understanding of a company's cash flow stability and utilization of debt is also beneficial to potential investors. It immediately assists them in determining if doing business with a firm will be profitable for them or not.
If a firm frequently uses its core resources to fulfill account payables, creditors may see it as unprofitable to work with them. Stagnant cash flow, along with the usage of excessive leverage, on the other hand, may prevent investors from participating in such a company endeavor.
FAQs on Non-Current Liabilities: Explained
1. What are non-current liabilities in accounting?
Non-current liabilities, also known as long-term liabilities, are a company's financial obligations that are not due for settlement within one year or the business's normal operating cycle. These are listed on the liabilities side of a company's Balance Sheet and represent debts that will be paid over an extended period.
2. What are the main characteristics of a non-current liability?
A non-current liability typically has the following characteristics:
- It arises from a past transaction or event, creating a present obligation for the company.
- The settlement of the obligation is expected to result in an outflow of economic resources (like cash or assets) from the company.
- The settlement is due more than 12 months after the reporting date or beyond the company's normal operating cycle.
3. What are some common examples of non-current liabilities?
Common examples of non-current liabilities found on a company's Balance Sheet include:
- Long-Term Loans: Bank loans or borrowings payable over a period longer than one year.
- Debentures: Long-term debt instruments issued by a company, backed by its reputation rather than specific assets.
- Bonds Payable: Similar to debentures but are secured by specific company assets (collateral).
- Deferred Tax Liabilities: Taxes on profits that are owed but will be paid in a future accounting period.
- Long-Term Lease Obligations: Payments due for assets taken on a capital lease that extend beyond one year.
- Long-term Provisions: Such as provisions for employee benefits (pension obligations) or multi-year product warranties.
4. How are non-current liabilities presented on a company's Balance Sheet as per Schedule III?
As per Schedule III of the Companies Act, 2013, non-current liabilities are presented on the 'Equity and Liabilities' side of the Balance Sheet. They appear under the main heading 'Non-Current Liabilities', which is placed after 'Shareholders' Funds' and before 'Current Liabilities'. Specific items like long-term borrowings, deferred tax liabilities, and other long-term liabilities are then listed as sub-headings under this category.
5. What is the key difference between Current Liabilities and Non-Current Liabilities?
The primary difference lies in the time frame for settlement. Current liabilities are obligations that a company expects to settle within its normal operating cycle or within 12 months from the reporting date (e.g., accounts payable, short-term loans). In contrast, non-current liabilities are obligations that are due for settlement after this period.
6. Why are non-current liabilities important for assessing a company's financial health?
Non-current liabilities are crucial for financial analysis as they provide insights into a company's long-term solvency and financial structure. Investors and analysts examine them to understand:
- Leverage: The extent to which a company relies on debt for financing, which indicates its risk level.
- Solvency: A company's ability to meet its long-term debt obligations. A high level of non-current liabilities compared to assets or equity can be a red flag.
- Cash Flow Stability: By comparing these liabilities to cash flow, an analyst can determine if the company generates enough cash to service its long-term debt comfortably.
7. What distinguishes Debentures from Bonds Payable, even though both are non-current liabilities?
The main distinction between Debentures and Bonds Payable is the presence of security or collateral. Bonds Payable are typically secured liabilities, meaning they are backed by specific assets of the company. If the company defaults, the bondholders can claim those assets. In contrast, Debentures are generally unsecured and are backed only by the company's general creditworthiness and reputation.
8. How does a Deferred Tax Liability (DTL) arise on a company's books?
A Deferred Tax Liability (DTL) arises due to a timing difference between the profit calculated as per accounting rules (Book Profit) and the profit calculated as per tax laws (Taxable Profit). When the accounting income is higher than the taxable income in a given period (e.g., due to different depreciation methods), the company pays less tax currently but will have to pay the difference in the future. This future tax obligation is recorded as a Deferred Tax Liability.
9. Why are long-term provisions like Pension Obligations or Warranties classified as non-current liabilities?
Long-term provisions like pension obligations and multi-year product warranties are classified as non-current liabilities because the obligation exists now, but its settlement is expected far in the future, beyond one year. For pension benefits, the company has an obligation to its employees, but the actual payment will occur upon their retirement. Similarly, for a product warranty spanning several years, the company must be prepared to meet claims, but most of these potential payments will fall due in future periods, making it a long-term obligation.
