sometimes when we take out a long term loan we might not pay it all at once in the future. Sometimes we make monthly payments or annual payments to repay the loan. Let's see how this affects the classification between current and long term liabilities on our balance sheet. So we might have what's called the current portion of long term debt. Okay. And this comes from the idea that some of some long term debt must be repaid in installments. Okay. So we might not pay it all at once in the future as one lump sum. We might break it up into smaller payments over time. So what we call the current portion of long term debt, Well this is gonna be a current liability. The current portion is the amount of principal. So remember when we're talking about a note payable we only care about the principal amount. We deal with the interest related to the note separately. So the focus here is on the principle and that's the principle that's payable within one year. Right when we're talking about current liabilities, well the current portion, it's going to be the principle that we have to pay back within one year. Okay So on the reporting date because what we usually do is we're just gonna have a note payable account, we take out a note payable for a million dollars or we would have a credit a long term liability for the note payable as a long term liability but then when it comes time to report we would make the calculation oh how much of that liability is due within a year. And then we would reclassify some of that note into the current liabilities. So that's what we do. We reclassify any upcoming payments from long term to current liabilities. Okay. So let's see how this works. In an example on january 2nd year one abc company signed $100,000. Long term note payable. So let's just think about that real quick. What would happen when we took out this note on january 2nd year one For a lack of space. I'll do it right over here. We would have debited cash right? We received cash and we would have credited note payable in the amount of $100,000 debit cash. Credit note payable. That's what we would have done when we first received the note right? Where when we first received the cash from this loan. So the note payable has a 10% interest rate and interest is payable each january 1st, so we're gonna be paying back interest annually. The repayment schedule also denotes payment of principal on each january 1st of $10,000 for years two through 11. So instead of just waiting 10 years to repay the entire $100,000 amount, we're gonna be paying it back in installments at $10,000 a year after each year on january 1st. So we want to make necessary journal entries on december 31st, year one and december 31st year too. So let's start here with year one on december 31st year one we have to think about two things. Our focus for this lesson is on the current portion of long term debt the principal amount. But we're also gonna have to adjust for interest. So we'll go over that as well because that these usually go hand in hand when we deal with these problems. But let's start with let's start with the current portion of the long term debt. Okay so the current portion, if you think about it, how many payments are we gonna have within the next year? It's december 31st year one. So between december 31st year one and december 31st year. To how much of that principle are we gonna have to repay? Well there's gonna be that $10,000 payment on january 1st year two, right? We're also gonna have one on january 1st year three but that's not in one year, that's after one year. So the only current portion is this $10,000 that we're gonna pay basically tomorrow on january 1st year two. Okay so that's gonna be a current portion of our long term debt. So notice at this point all of all of our debt is sitting in the note payable as a long term liability. When we first made our journal entry we would have credited note payable for $100,000 and we would have had that as a long term liability. So what we're gonna do is we're gonna reclassify so this is gonna be a reclassifying entry right here And then we're going to deal with the interest separately. So to reclassify what we're gonna do is we're going to debit the note payable because we're going to reduce the long term liability by the 10,000 that's due in the current portion. And then we're going to credit current portion of long term debt. I'm gonna do it like this to save space current portion of long term debt. That's our that's our credit. So we're creating a new liability in the current liabilities section. You see all we did was reclassify we still owe $100,000 except instead of owing $100,000 in the long term section. We took 10,000 out of the long term and we moved it to the current section. So it's still all liabilities. It's just how we classified it. Now let's deal with the interest because we have to do an interest payable entry as well. Right Because it's been a year. And in this year. Well we've accrued some interest. We took the loan out on january 2nd year one and a whole year has passed. So we have to accrue accrue for a whole year's worth of interest. So how much interest has have we incurred in the past year. Well there was $100,000 in principle times the 10% interest rate? 0.10. And then we have a time factor, right? We always do by the proportion of the year. Well it's been a whole year, right? It's not like it's only been a few months. We didn't take this out in like july and it's like half a year's worth. No, this is a whole year's worth of interest. So we just take an entire year's worth of interest and that's gonna be $10,000 in this case. So we're gonna have interest expense, right? Because we've incurred this expense in the current year of 10,000 And we're gonna have interest payable because we haven't paid it yet. We're gonna pay that interest off on January one. Right? The interest is payable on January one. So on december 31st we haven't paid it yet interest payable as a liability for the 10,000 in interest that we're gonna have to pay. Okay. And that's also gonna be a current liability obviously right because that's going to be paid within a year. It's going to be paid on january 1st. So notice what we've done here, we've reclassified some of our long term liability to current and then we also have to accrue for interest for the time that has passed. But the focus of this lesson is on that reclassification. It's not that crazy of a journal entry. We're just taking some of the long term portion and making it current. So let's go ahead and use that information here in our uh accounting equation or fundamental equation. And let's just deal with the reclassification Because we've dealt with interest before. Let's just put the reclassification entry in here. All that we're doing is reclassifying liabilities. Right? Our note payable has gone down by 10,000. But the current portion Well, the current portion went up by 10,000. Right? This went down by 10,000 and this one up by 10,000. So all we did was reclassify Some of our long term note payable to current. Alright. Let's pause here and then. Let's see how we're gonna do our entry in year two. Alright, let's check that out in the next video.
Current Portion of Long Term Debt (Year 2)
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Alright so now let's consider the adjusting entries on december 31st year two. So now another year has passed. But before we get there I want to quickly just so you see it. Let's talk about what happened on january 1st year two. So I'm just gonna write this and I'm gonna I'm gonna erase it again for a lack of space. But this this should be pretty obvious. We've dealt with these types of things before. So on january 1st year two we would have made some journal entries right? Because this is when we paid off that current portion of the long term debt and we also paid off this interest payable. So we would have made a journal entry to get rid of the current portion. Right because we're gonna pay off on january 1st we're gonna get rid of the current portion of the long term debt with a debit of 10,000. And we're going to credit cash right for 10,000. And this is happening on january 1st year two we're going to pay off that current portion. Remember we're paying off the principal in $10,000 installments every year on january 1st. And we would have also paid off the interest payable that we have here from our interest entry. We had taken 10,000 in interest payable. Well that was also due on january 1st year two and we would have got rid of that liability with a debit of 10,000 and we would have credited cash again because these are all payments that we made at that point. So we would have credited cash to get rid of those that that liability and we would have got rid of the current portion of long term debt. Okay so that should make sense. This is basically what we've done before with adjusting entries. So let's go ahead and see what happens on december 31st year two. Okay so on December 31st year too. Well now we're making adjusting entries again we're gonna need to be reclassifying some of our long term debt to short term and we're gonna have to accrue for interest again. The interest is going to be a little different this year because we don't have as much principal left. So that's gonna be that's why I wanted to focus on this because you're going to see that the interest is a little less because we have less principal outstanding. So our reclassification entry let's start there where we're reclassifying some of our long term debt into short term debt. Right so again remember at first we took out $100,000 but we've paid back 10,000 so we only owe 90,000 left. Right now we still have a long term liability for 90,000 but now we're gonna have to get rid of another 10,000 of that into our current liabilities for the upcoming payment on january 1st year three. Right because now we're in the second year. So on december 31st year two we would again do the same exact entry. Oops we're gonna debit our notes payable. Right we're gonna reduce the long term liability of notes payable By 10,000 with a debit. And we're going to credit current portion we're gonna create this liability again current portion of long term debt with the credit for 10,000. So it's the same entry that we made in january. Excuse me in december 31st year one. Well we're making the same $10,000 payment in january 1st year three. So we need to reclassify another 10,000 from the long term to the current portion at the end of year two. Okay so that's the same entry. But now let's think about the interest. So the interest is gonna be kind of interesting right here interesting interest. So let's think about how much is left that we oh let me get out of the way here. So in this case the interest payment. Well we don't owe 100,000 anymore. Right we paid back on january 1st we paid back 10,000 of that principle. So our principle in this case It's 90,000 rather than 100,000. Right because we've paid back already 10,000 of the principle So we don't pay interest on the full 100,000 anymore. We only pay interest on the amount that we owe to them. So it's gonna be 90,000 times 10%. And there's only gonna be 9000 in interest this year. Okay so let's go ahead and see what our entry looks like, our interest expense. Well it's gonna be 9000 this year And our interest payable that we're going to pay off on January one of the following year. Well that's gonna be 9000 as well and you can imagine each year as we pay off more and more of the principle that interest expense is gonna keep going down and down each year until we don't know any more money and we've paid back all the principal. Cool. So the same thing, we're just reclassifying some of our liabilities here right in a reclassification entry just like before we're taking some of the note payable And we're decreasing that by 10,000. And we're reclassifying it to the current portion. So all we're doing is making some of the long term liability into a current liability since we have to pay it back sooner. Okay so the current portion of long term debt isn't that crazy? Usually when you see these in multiple choice questions, all you got to focus on is how much are we paying back within the next year and that's gonna be the current portion? How much is not due within the next year? That's the long term portion? Alright so let's go ahead and pause here and you guys try the practice problem
ABC Company is preparing the liabilities section of its December 31, 2018 balance sheet. Selected information includes $20,000 in accounts payable, $100,000 in bonds payable, $80,000 of short-term debt, $10,000 in wages payable, $10,000 in prepaid rent expense, and $20,000 of unearned revenue. Furthermore, on January 1, 2018, ABC Company signed a $60,000, 10% note payable with interest payable annually on December 31. The principal of the note payable is repaid in $10,000 annual installments on January 1 of each year. The total of ABC’s current liabilities is: