Many businesses incur liabilities to fund their operations. These liabilities arise when the business owner starts planning the business, when the company chooses to expand or when the company requires additional cash to maintain operations. Companies incur these liabilities by obtaining a note payable or a long-term bank loan. The company reports the liabilities on the balance sheet at the end of each period. To accurately report these balances, the company needs to understand how to calculate the balances.
The balance sheet details the company’s financial position as of the last day in the accounting period. It lists the balance of each permanent account. Permanent accounts include assets, liabilities and owner’s equity accounts. The total balance of all asset accounts must equal the combined balances of all liability and equity accounts. The balance sheet allows all financial statement users to determine the amount of money the company received from its debt, or liabilities, versus the amount of money received from owner investments.
The liabilities of a company fall into two categories: current liabilities and long-term debt. Current liabilities refer to money or services owed to others, which must be paid within one year. Long-term debt refers to money or services owed to others that will be paid after one year. Some long-term debt requires payments in the current year and beyond the current year. The company separates these debts into two classifications. Payments that will be paid in the next 12 months are a current liability; payments that will be paid after the next 12 months are a long-term debt.
Notes Payable and Long-term Liabilities
Notes payable refers to money borrowed for the company for which the company issues a promissory note to the lender. The promissory note includes the face value of the note, the interest rate and the term of the note. A note payable can be a current liability if it is due within the year or a long-term debt if it extends beyond the year. Long-term liabilities include only money borrowed that extends beyond one year.
The company calculates the balance of notes payable or long-term liabilities by taking the original face value of the loan and subtracting any principal payments made. The company calculates the principal payments made by first determining the amount of interest paid. To calculate the interest, the company multiplies the remaining principal balance by the interest rate by the number of days in the period divided by 365.