Measuring and recording liabilities

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on June 22, 2021

Liabilities are generally recorded and disclosed at the present value of the future payments computed using a realistic interest rate. The existence of a nominal interest rate that is unrealistic makes the measurement task more difficult. The effect of complying with the rule is the description of the proper relationship between the amount actually borrowed and the amount of interest incurred during the life of the liability.

Example

As an example of the use of present value computations, consider the facts about this asset acquisition:
recording liabilities example
The amount of the debt is as follows:
measurements of liabilities
This entry would be made at the time of the purchase:
measurements of liabilities journal entries
This journal entry would be recorded on December 31, 20×1, when the first payment is made:
measurements of liabilities journal entry
The balance sheet would report the note balance of $44,580 on December 31, 20×1. The following example shows the calculation of the annual interest expense and the amount that would be disclosed for the note for each year in its life.
Amortization of note payable
An alternate approach to recordkeeping would have recognized the difference between the present value of the note ($57,661) and the sum of the future payments ($75,000) as a discount of $17,339. Then, subsequent entries would have credited the discount instead of the note payable. While GAAP call for disclosure of the amount of the discount, it need not be recorded formally in the accounts. However, as a practical matter, recording the discount would virtually assure its disclosure in the balance sheet.
As exceptions to this general treatment, GAAP does not require that present value measurements be applied to trade receivables or payables that are due within “approximately one year” or to deposits that are to be applied to the purchase or sale of goods. The apparent reason for the exceptions is the probable immateriality of the amounts.

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