Noncurrent Liabilities

Question: Notes and bonds payable serve as the predominant source of reported noncurrent liabilities in the

United States. Virtually all companies of any size raise significant sums of money by incurring debts of this type.

However, a quick perusal of the financial statements of many well-known companies finds a broad array of other

noncurrent liabilities.

• Sears Holdings Corporation discloses capital lease obligations of approximately $650 million as of

January 31, 2009.

• Southwest Airlines Co. reports deferred income tax liabilities of over $1.9 billion on December 31, 2008.

• The balance sheet for Alcoa Inc. at that same December 31, 2008, date lists a $2.73 billion liability (over

10 percent of the company’s total) labeled as “accrued postretirement benefits.”

These other noncurrent liability figures represent large amounts of debts beyond traditional notes and bonds.

Some understanding of such balances is necessary in order to comprehend the information being conveyed in a set

of financial statements. The reporting of liabilities such as these is explored in great depth in upper-level financial

accounting courses. However, a basic level of knowledge is essential for every potential decision maker, not just

those few who chose to major in accounting in college.

In this chapter, leases and related liabilities will be explored first. To illustrate, assume that the Abilene Company

needs an airplane to use in its daily operations. Rather than buy this asset, an airplane is leased from a business

that owns a variety of aircraft. Perhaps Abilene prefers to push the payments off into the future as far as possible.

The lease is for seven years at a cost of $100,000 per year. On the day that this lease is signed, should Abilene

report a liability and, if so, is the amount the first $100,000 installment, the $700,000 total of all payments, or

some other figure?

How is a liability reported in connection with the lease of an asset?

Answer: For the Abilene Company, the liability balance to be reported here cannot be determined based purely on

the information that is provided. When a lessee (the party that will make use of the asset) signs an agreement such

as this, the lease transaction can be recorded in one of two ways based on the terms of the contract.

• Abilene might be obtaining the use of this airplane through an operating lease, a rental arrangement. If so,

the liability to be recognized when the contract is signed is $100,000, only the amount due immediately.

Upon payment, reported debt is reduced to zero despite the requirement that six more installments will have

to be paid.

• The transaction could also have met the criteria for classification as a capital lease, the equivalent of buying

the airplane. In that case, the initial liability recognized by Abilene is the present value of the total $700,000

in cash payments.