Long-term Debt

Definition

Long-term debt refers to financial obligations that a company or individual has to repay over a period of more than one year. It is a type of liability that is not due within the current accounting period and is typically used to finance long-term investments or assets.

5 Must Know Facts For Your Next Test

1. Long-term debt is a type of noncurrent liability, which means it is not due within the current accounting period.
2. Examples of long-term debt include bonds, mortgages, and long-term loans from financial institutions.
3. Long-term debt is often used to finance the purchase of long-term assets, such as property, plant, and equipment.
4. The interest paid on long-term debt is considered an expense and is reported on the income statement.
5. The principal payments on long-term debt are reported as a financing activity on the cash flow statement.

Review Questions

• Explain how long-term debt is classified on the balance sheet and how it differs from current liabilities.
  • Long-term debt is classified as a noncurrent liability on the balance sheet, meaning it is not due within the current accounting period, typically more than one year from the balance sheet date. This is in contrast to current liabilities, which are obligations that must be paid within one year or the normal operating cycle, whichever is longer. The distinction between current and noncurrent liabilities is important for assessing a company's short-term liquidity and long-term solvency.
• Describe the relationship between long-term debt and the financing of long-term assets.
  • Companies often use long-term debt to finance the acquisition of long-term assets, such as property, plant, and equipment. This allows the company to spread the cost of these assets over a longer period, aligning the asset's useful life with the repayment schedule of the debt. The interest paid on long-term debt is considered an expense and is reported on the income statement, while the principal payments are reported as a financing activity on the cash flow statement. The use of long-term debt to finance long-term assets can be an effective way to leverage a company's resources and support its growth and expansion.
• Analyze the impact of long-term debt on a company's financial statements and overall financial position.
  • The presence of long-term debt on a company's balance sheet can have significant implications for its financial position and performance. On the one hand, long-term debt can provide the necessary capital to fund long-term investments and support the company's growth. However, it also increases the company's leverage and financial risk, as the interest payments and principal repayments must be made regardless of the company's financial performance. This can impact the company's liquidity, solvency, and profitability, as measured by ratios such as the debt-to-equity ratio, interest coverage ratio, and return on assets. Careful management of long-term debt is crucial to maintain a healthy financial position and support the company's long-term sustainability.

Related terms

Current Liabilities:

Current liabilities are obligations that a company or individual must pay within one year or the normal operating cycle, whichever is longer.

Equity:

Equity represents the residual interest in the assets of an entity that remains after deducting its liabilities. It includes items such as common stock, additional paid-in capital, and retained earnings.

Noncurrent Liabilities:

Noncurrent liabilities are obligations that are not due within the current accounting period, typically more than one year from the balance sheet date.