Current portion of long-term debt
| Current portion of long-term debt |
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The current portion of long-term debt is an individual line item in the financial statements, exactly in balance sheet. The balance sheets presents what the company owns (assets) and how the assets are financed (liabilities). The liabilities are divided due to the source of financing for equity and liabilities[1]. Then, liabilities are identified as long-term and short-term (current) liabilities. The current liabilities means that part of liabilities which have to be paid during next 12 months. In balance sheet liabilities can also be classified as financial and non-financial liabilities. Financial liabilities are positions debt generally like:
- credits,
- loans,
- bonds,
- leasing, etc..
The current portion of long-term debt is the amount of long-term debt that is scheduled for payment within the 12 months. The current portion of long-term debt is a part of liabilities, exactly current liabilities. For example, the company has a $ 2 000 000 loan. Up to now the company has paid $ 500 000 during 2 years. In next 6 years the company has to repay the remaining part of the loan i.e. $ 1 500 000. The annual installment of the loan is $ 250 000.In the balance sheet $ 250 000 will be identified as the current portion of long-term debt. The remaining part of the loan in amount $ 1 250 000 will be classified as long-term debt.
This position is often observed by lenders, creditors and investors. Stakeholders want to analyze whether the company has sufficient liquidity to pay off short-term liabilities. Creditors, creditors and investors analyze whether the company has sufficient current assets to cover short-term liabilities. If assets are outstanding for repayment of current liabilities, the stakeholders perceive the company's financial situation as positive. However, if the assets are not sufficient to cover current liabilities, the creditors may terminate the financing and the investors may sell their shares. The current portion of long-term debt is use in calculation of working capital which is the differences between the amount of company's current assets and the amount of current liabilities. Working capital is the measure of the operational efficiency and short-term financial condition of the company[2].
The lack of the information of current portion of long-term debt may lead investors and creditors to mislead. Stakeholders may misinterpret the financial condition of the company and the financial need during the next 12 months. For example, the company has short-term liabilities of $1 000 000 and $10 000 000 long-term liabilities. Stakeholders understand that in the next 12 months, the company has to pay off $ 1 000 000 in liabilities. It is important that current part of long-term debt amounts $ 5 000 000. This means that in the next year the company will have to pay liabilities worth six times higher i.e. $ 6 000 000. The lack of the information of current portion of long-term debt misleads investors about the current financial condition of the company Financial Accounting.
The amount of current portion of long-term debt
The amount of current portion of long-term debt should also be analyzed by the company's managers. Ongoing monitoring of the value of the current portion of long-term liabilities allows to ensure an appropriate level of funds for repayment of liabilities on time. Accumulation of significant value of liabilities in the short term may lead to the company's insolvency, loss of credibility among creditors, contractors and shareholders, and ultimately even to the company's bankruptcy. The company can maintain a long-term debt so that it is never classified as a current liability. This situation is possible by periodically rolling the debt on instruments with balloon payments or longer maturities. If the debt obligation is routinely rolled, the balloon payment never becomes due in the next 12 months. As a consequence, it will never be classified as a short-term liability [3].
It is possible to suddenly reclassify the entire long-term debt into the current part of the company's liabilities. This situation occurs if debt is an outstanding loan obligation. In this case, the loan agreement often specifies that the entire loan is payable immediately. As a result, the entire debt will become a short-term liability.
Footnotes
References
- Duchac J., Reeve J.M., Warren C.S.,(2009), Financial & Managerial Accounting, South-Western Cengage Learning, 436-482
- McLean R., Berardino P., (2017), The Motives for Long-Term Debt Issues
- Norton C., Porter G., (2010), Financial Accounting: The Impact on Decision Makers, South-Western Cengage Learning, 427-430
- Stickney C.P. (2010), Financial Accounting: An Introduction to Concepts, Methods and Uses, South-Western Cengage Learning, 105-144 (Balance Sheet: Presenting and Analyzing Resources and Financing), 385-416 (Working Capital)
- Stowe J.D., (2007), Equity Asset Valuation, John Wiley & Sons, 113-118
- Van Rixtel A., Gonzalez L., Yang J., (2015),The determinants of long-term debt issuance by European banks: evidence of two crises,
Author: Łukasz Kaczmarczyk
