Non-Current (Long-Term) Liabilities

Non-current liabilities arise from different sources of financing and different types of creditors. Bonds are a common source of financing from debt markets. Key points in accounting and reporting of non-current liabilities include the following:

• The sales proceeds of a bond issue are determined by discounting future cash payments using the market rate of interest at the time of issuance (effective interest rate). The reported interest expense on bonds is based on the effective interest rate.
• Future cash payments on bonds usually include periodic interest payments (made at the stated interest rate or coupon rate) and the principal amount at maturity.
• When the market rate of interest equals the coupon rate for the bonds, the bonds will sell at par (i.e., at a price equal to the face value). When the market rate of interest is higher than the bonds’ coupon rate, the bonds will sell at a discount. When the market rate of interest is lower than the bonds’ coupon rate, the bonds will sell at a premium.
• An issuer amortises any issuance discount or premium on bonds over the life of the bonds.
• If a company redeems bonds before maturity, it reports a gain or loss on debt extinguishment computed as the net carrying amount of the bonds (including bond issuance costs under IFRS) less the amount required to redeem the bonds.
• Debt covenants impose restrictions on borrowers, such as limitations on future borrowing or requirements to maintain a minimum debt-to-equity ratio.
• The carrying amount of bonds is typically the amortised historical cost, which can differ from their fair value.
• Companies are required to disclose the fair value of financial liabilities, including debt. Although permitted to do so, few companies opt to report debt at fair values on the balance sheet.

1. A lease is a contract in which a lessor grants the lessee the exclusive right to use a specific underlying asset for a period of time in exchange for payments.
2. Leasing is a common arrangement because it has several advantages over purchasing an asset outright: less upfront cash commitment, generally low interest rates, and lower risks associated with ownership such as obsolescence.
3. Leases are classified as operating or finance leases. Finance leases resemble an asset purchase or sale while operating leases resemble a rental agreement.
4. US GAAP and IFRS share the same accounting treatment for lessors but differ for lessees. IFRS has a single accounting model for both operating leases and finance lease lessees, while US GAAP has an accounting model for each.

• Lessees reporting under IFRS and finance lease lessees reporting under US GAAP recognize a lease liability and corresponding right-of-use asset on the balance sheet, equal to the present value of lease payments. The liability is subsequently reduced using the effective interest method and the right-of-use asset is amortized. Interest expense and amortization expense are shown separately on the income statement. The statement of cash flows shows the entire lease payment.
• Operating lease lessees reporting under US GAAP recognize a lease liability and corresponding right-of-use asset on the balance sheet, equal to the present value of lease payments. The liability is subsequently reduced using the effective interest method, but the amortization of the right-of-use asset is the lease payment less the interest expense. Interest expense and amortization expense are shown together as a single operating expense on the income statement.
• Finance lease lessors (IFRS and US GAAP) recognize a lease receivable asset equal to the present value of future lease payments and de-recognize the leased asset, simultaneously recognizing any difference as a gain or loss. The lease receivable is subsequently reduced by each lease payment using the effective interest method. Interest income is reported on the income statement, typically as revenue, and the entire cash receipt is reported under operating activities on the statement of cash flows.
• Operating lease lessors (IFRS and US GAAP): The balance sheet is not affected—The lessor continues to recognize the underlying asset and depreciate it. Lease revenue is recognized on a straight-line basis on the income statement and the entire cash receipt is reported under operating activities on the statement of cash flows.
• Two types of pension plans are defined contribution plans and defined benefits plans. In a defined contribution plan, the amount of contribution into the plan is specified (i.e., defined) and the amount of pension that is ultimately paid by the plan (received by the retiree) depends on the performance of the plan’s assets. In a defined benefit plan, the amount of pension that is ultimately paid by the plan (received by the retiree) is defined, usually according to a benefit formula.
• Under a defined contribution pension plan, the cash payment made into the plan is recognised as pension expense.
• Under both IFRS and US GAAP, companies must report the difference between the defined benefit pension obligation and the pension assets as an asset or liability on the balance sheet. An underfunded defined benefit pension plan is shown as a non-current liability.
• Under IFRS, the change in the defined benefit plan net asset or liability is recognised as a cost of the period, with two components of the change (service cost and net interest expense or income) recognised in profit and loss and one component (remeasurements) of the change recognised in other comprehensive income.
• Under US GAAP, the change in the defined benefit plan net asset or liability is also recognised as a cost of the period with three components of the change (current service costs, interest expense on the beginning pension obligation, and expected return on plan assets) recognised in profit and loss and two components (past service costs and actuarial gains and losses) typically recognised in other comprehensive income.
• Solvency refers to a company’s ability to meet its long-term debt obligations.
• In evaluating solvency, leverage ratios focus on the balance sheet and measure the amount of debt financing relative to equity financing.
• In evaluating solvency, coverage ratios focus on the income statement and cash flows and measure the ability of a company to cover its interest payments.