Many financial statement users want to know what type of liabilities companies owe. Businesses report a variety of liabilities on their balance sheet. These liabilities include current liabilities and long term debt. Current liabilities refer to obligations the company must satisfy within one year. These include vendor invoices and short term borrowing. Long term debt refers to any money owed that will not be paid within the year. These include notes payable and capital leases.
Notes Payable
A note payable represents money borrowed with a formal agreement between the company and the lender. The formal agreement, or promissory note, includes information regarding the term of the note, the interest rate and the face value. The company signs the note in exchange for a purchase or money to use in the business. A note payable can last for any length of time, including several months or several years.
Capital Lease
A capital lease works similarly to a purchase. The company leases property from another business, but records it in the financial records as a purchase. Ownership of the property remains with the lessor and the company makes regular lease payments. In order for the lease to qualify as a capital lease, the company must meet specific criteria, such as a bargain purchase option or the term of the lease extending beyond 75 percent of the asset’s life.
Classification
Notes payable and a capital leases affect different accounts on the balance sheet, each classified differently. A note payable can refer to a current liability or long term debt, depending on the length of the note. A note payable due within one year represents a current liability. A note payable due after a term of longer than a year represents long term debt. The company records a capital lease like a purchase. It records an asset for the property and a liability for the money owed.
Balance Sheet Reporting
The balance sheet lists the assets, liabilities and equity accounts. Notes payable and capital lease balances appear in different sections on the balance sheet. The property leased under a capital lease appears in the assets section as a fixed asset. The money owed for the lease appears in liabilities section as long term debt. The notes payable also appears in the liabilities section. If the note payable is due within a year, it appears with the current liabilities. If the note payable will not be due within the year, it appears with the long term debt.
