It is important to understand the difference between Current and Long Term Liabilities. Current Liabilities are things that a company is required to pay in less than on year. This kind of liability would include federal and state payroll tax liabilities which are usually due on a monthly or quarterly basis. It would also include short term loans that are payable within one year.
A Long Term Liability such as a bank loan is normally used to purchase assets for a business. For example, let’s say that a business takes out a 3 year bank loan for office furniture and equipment. The office furniture and equipment become assets to the business but at the same time the loan used to acquire them becomes a liability. In our bookkeeping we post the total amount of the loan ($3,000 for example) to the Bank Loan A long term liability account. That account now shows that the business ‘owes’ or is ‘liable’ for the $3,000. The money from the loan is deposited into the business bank account and a check is written for $3,000 to the office store for the office furniture and equipment. This check is posted to the fixed asset account Furniture & Equipment, not the office expense account. It now looks like this in the chart of accounts:
• Bank Loan A (Long-term Liability) – $3,000
• Furniture & Equipment (Fixed Asset) – $3,000
Let’s imagine that these assets were purchased in January, and that a year has passed. The loan has been paid down to $2,000 and the Furniture was depreciated using a 7 year straight line depreciation method. These accounts now look like this:
• Bank Loan A (Long-term Liability) – $2,000
• Furniture & Equipment (Fixed Asset) – $2,571.43
• Depreciation – Furniture & Equipment (Expense) – $428.57
As you can see in this example, we have now added another expense account to the chart of accounts to keep track of the depreciation of the furniture and equipment. We need to do this, so that the books will correctly show the value of our current assets as they are depreciated. Now we can finally count some of our purchase as an expense to the business under depreciation expense. The $428.57 will be entered on the business tax return as an expense.