Contents
- What are non current liabilities?
- Types of non current liabilities
- Important financial ratios incorporating non current liabilities
- Why are non current liabilities important to investors?
- Non current liabilities on the balance sheet
What are non current liabilities?
Non current liabilities are enduring financial obligations documented on an entity’s balance sheet that involve settlements that are scheduled to occur more than twelve months into the future.
According to AASB 101, financial liabilities, which are obligations to pay money, are classified as non current liabilities if they provide long term financing for an entity and are not expected to be settled within twelve months after the end of the reporting period.
In simpler terms, if an entity has borrowed money or incurred debts that are intended for long term financing needs, like buying property or funding a major project, and these debts are not due for repayment within the next year, they are considered non current liabilities.
This means that the entity has some time, usually more than a year, to fulfil its obligations and repay these loans or debts.
In contrast, current liabilities pertain to short term debts that are due within the next twelve months.
Noncurrent liabilities are assessed in relation to cash flow to determine an entity’s ability to fulfil its financial commitments over an extended period. Lenders tend to focus on short term liquidity and the magnitude of current liabilities, while long term investors utilise noncurrent liabilities as an indicator of whether an entity is relying excessively on borrowed funds.
Types of non current liabilities
Noncurrent liabilities include a range of long term financial obligations. Following are various types of non current liabilities each with distinct characteristics and implications for an entity’s financial outlook:
Capital Leases: These represent contracts where an entity, as a renter, holds temporary rights to use an asset and assumes financial obligations. An example is a yearlong apartment rental, where the renter has a financial commitment beyond the current year.
Bonds Payable: These are long term agreements where a lender provides funds to an entity for capital intensive projects. They become noncurrent liabilities when the repayment period exceeds one year, and the borrower typically pays accrued interest over the project’s duration.
Mortgage Payable: Mortgage payable is a long term liability reflecting the amount owed by a property owner for a loan secured by a home or commercial property. While individual mortgage payments are short term liabilities, the overall amount owed is classified as a noncurrent liability.
Long Term Notes Payable: Long term notes payable, or promissory notes, entail borrowers committing to repay principal costs along with accrued interest on a specified future date. These notes help entities finance the acquisition of assets like land, buildings, or machinery.
Deferred Tax Liabilities: These represent taxes owed by an entity for specific periods but deferred for payment to a later date. Businesses may incur higher tax obligations in the future, depending on current transactions eligible for tax deferral.
Post Employment Benefits: Post employment benefits encompass the benefits employees and their families may receive after an employee retires. Such retirement plans accumulate funds over an extended period, provided the employee remains employed throughout that duration.
Unamortised Investment Tax Credits (UITC): UITC signifies the difference between the original cost of an asset and its current depreciated value. The portion of the asset’s value that has already depreciated is considered a noncurrent liability.
Debentures: Debentures are long term, unsecured bonds often issued by governments, relying on the issuer’s reputation, creditworthiness, and credibility. Unlike secured bonds, debentures lack collateral or security backing, minimising the lender’s risk.
These non current liabilities represent various financial obligations that an entity may have over an extended period, and they play a crucial role in the entity’s long term financial planning and management.
Classification of Liabilities Based on Refinancing and Grace Periods
According to AASB 101, if the entity has the right, at the end of the reporting period, to extend the repayment of a liability for at least twelve months using an existing loan agreement, it should classify that liability as non current.
This means that even if the obligation would otherwise be due within the next year, the entity can consider it as a long term liability because it has the option to extend the repayment period.
Additionally, if the lender agrees by the end of the reporting period to provide a grace period lasting at least twelve months beyond the reporting period, during which the entity can fix any breaches or issues related to the obligation, and the lender cannot demand immediate repayment, the entity can classify the liability as non current.
Important financial ratios incorporating non current liabilities
Investors and creditors utilise various financial ratios to evaluate an entity’s liquidity risk and leverage. These ratios offer insights into the entity’s financial strength and its capacity to manage its financial obligations effectively.
Debt ratio
The debt ratio compares an entity’s total debt to its total assets. It provides an overall view of the entity’s leverage or indebtedness. A lower percentage indicates lower leverage and a stronger equity position, suggesting lower financial risk.
Conversely, a higher ratio implies that the entity is taking on more financial risk due to a higher level of debt relative to its assets.
Interest coverage ratio
The interest coverage ratio is calculated by dividing an entity’s earnings before interest and taxes (EBIT) by its interest payments on debt for the same period. It assesses whether the entity generates enough income to cover its interest expenses.
A higher ratio signifies that the entity has ample earnings to meet interest payments, indicating lower financial risk.
A lower ratio may suggest that the entity is struggling to cover its interest costs, potentially indicating higher financial risk.
Other key ratios
- Long Term Debt to Total Assets Ratio: This ratio specifically focuses on noncurrent liabilities (long term debt) in relation to total assets. It helps assess the proportion of long term debt compared to the entity’s total asset base.
- Long Term Debt to Capitalisation Ratio: This ratio divides noncurrent liabilities (long term debt) by the total capital available. It aids in understanding the extent to which long term debt is financed through the entity’s capital structure.
- Cash Flow to Debt Ratio: The cash flow to debt ratio determines how long it would take for an entity to repay its debt if it allocated all of its cash flow to debt repayment. It offers insights into the entity’s ability to generate sufficient cash flow to service its debt obligations.
A lower ratio indicates a shorter time required to repay debt, suggesting lower risk. Conversely, a higher ratio suggests a longer period needed to repay debt, potentially indicating higher risk.
Why are non current liabilities important to investors?
Investors analyse non current liabilities as a crucial aspect of their investment analysis because it grants them access to valuable insights into an entity’s financial stability. This examination helps gauge the entity’s risk profile and its ability to fulfil long term financial obligations.
By considering these factors, investors can make well informed decisions regarding their investments in a specific entity’s securities.
There are several key reasons why investors focus on non current liabilities:
Assessing Financial Health
Non current liabilities provide essential information about an entity’s long term financial health and its capacity to meet financial commitments without jeopardising its overall financial well being.
Evaluating Risk
These liabilities serve as indicators of potential financial risk. High levels of long term debt suggest a greater risk of financial distress, especially if the entity faces challenges in servicing its debt.
Scrutinising Liquidity:
Investors examine non current liabilities alongside an entity’s cash flow and assets to gain insights into its liquidity position. Even though these liabilities are not immediately due, investors want assurance that the entity can meet these obligations when they eventually come due.
Projecting Future Cash Flow
Non current liabilities often represent future cash outflows. Investors consider these liabilities when analysing the entity’s expected future cash flow and its ability to generate sufficient funds to fulfil long term obligations.
Expansion and Growth
Non current liabilities may be incurred to finance growth initiatives such as capital expenditures, research and development projects, or acquisitions. Investors assess whether these investments are likely to generate returns in the future and drive the entity’s growth.
Comparing Entities
Investors frequently compare non current liabilities among different entities within an industry or sector. This comparison helps identify entities with more aggressive or conservative financing strategies, aiding investors in making informed investment decisions.
Thus, the analysis of non current liabilities provides investors with a comprehensive understanding of an entity’s financial situation, enabling them to make prudent investment choices that align with their risk tolerance and investment objectives.
Non current liabilities on the balance sheet
As per AASB 101, the balance sheet section dedicated to non current liabilities is typically arranged based on the maturity dates of these obligations. Consequently, the presentation of non current liabilities may vary among entities.
Just like any other entry on the balance sheet, any credit or debit recorded in the non current liabilities section must be balanced by an equal and opposite entry elsewhere in the financial records.
For instance, if an entity borrows $2 million from creditors, it would debit the cash account for $2 million while simultaneously crediting the notes payable account for the same amount.
Changes in non current liabilities also have corresponding effects on other parts of the financial statements. For example, if an entity records a $2 million cash inflow in the cash flow from financing section due to an increase in notes payable, this change will be reflected.
When the interest on the loan becomes due in less than one year, the notes payable account will be debited, while the interest payable account will be credited. This adjustment will impact the income statement, particularly with regard to tax deductible interest expenses.
Subsequently, if the entity pays the interest, it will credit the cash account while debiting the interest payable account. This transaction will result in the recognition of interest expenses on the income statement and a corresponding cash outflow listed in the cash flow from financing section of the cash flow statement.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.