FINANCIAL

ACCOUNTING II
SUBMITTED BY:
NAME: AROOJ FATIMA
ROLL NO: 21:F1:136
SEMESTER : 2ND
SESSEION: ADP (IT)

SUBMITTED TO:
SIR HAMZA ZAHEER
Table of Contents
What are liabilities?............................................................................................................................2
How Liabilities Work..........................................................................................................................2
Types of Liabilities on the Balance Sheet...........................................................................................2
Short-term Liabilities......................................................................................................................3
Accounts Payable.........................................................................................................................3
Principle and Interest Payable....................................................................................................3
Short-term Loans.........................................................................................................................3
Taxes Payable...............................................................................................................................3
Accrued Expenses........................................................................................................................3
Unearned Revenue.......................................................................................................................4
Long-term Liabilities...........................................................................................................................4
Long-term Notes Payable....................................................................................................................4
Types of long-term liabilities..............................................................................................................4
Deferred Taxes.................................................................................................................................4
Bonds Payable..................................................................................................................................5
Mortgage Payable............................................................................................................................5
Capital Leases..................................................................................................................................5
Contingent Liabilities......................................................................................................................5
Example........................................................................................................................................5
Liabilities used in Pakistan.................................................................................................................5
Tax payable..........................................................................................................................................5
Examples of Taxes Payable.............................................................................................................6
Presentation of Taxes Payable........................................................................................................6
Mortgages.............................................................................................................................................6
How Mortgages Work.....................................................................................................................6
Example........................................................................................................................................6
The Mortgage Process.....................................................................................................................6
Types of Mortgages.............................................................................................................................7
Fixed-Rate Mortgages.....................................................................................................................7
Adjustable-Rate Mortgage (ARM).................................................................................................7
Interest-Only Loans.........................................................................................................................7
Reverse Mortgages..........................................................................................................................7
Average Mortgage Rates for 2022......................................................................................................8
Bonds Payable......................................................................................................................................8
 Example of Bonds Payable..............................................................................................................8
Types of bonds.....................................................................................................................................8
Serial bonds......................................................................................................................................8
Sinking fund bonds..........................................................................................................................8
Convertible bonds............................................................................................................................9
Registered bonds..............................................................................................................................9
Bearer bonds....................................................................................................................................9
Secured bonds..................................................................................................................................9
Debenture bonds..............................................................................................................................9
Short-term and long- term loan..........................................................................................................9
Short-term loan..................................................................................................................................10
Characteristics of Short-Term Loans...........................................................................................10
Types of Short-Term Loans..............................................................................................................10
1. Merchant cash advances...........................................................................................................10
2. Lines of credit............................................................................................................................10
3. Payday loans...............................................................................................................................10
4. Online or Installment loans.......................................................................................................10
5. Invoice financing........................................................................................................................11
Advantages of Short-Term Loans....................................................................................................11
1. Shorter time for incurring interest...........................................................................................11
2. Quick funding time....................................................................................................................11
3. Easier to acquire........................................................................................................................11
Disadvantage......................................................................................................................................11
Key Takeaways..................................................................................................................................11
Long-Term Loans..............................................................................................................................11
Long-Term Financing Example....................................................................................................12
MGP Ingredients: Obtained long-term financing for expansion and growth.......................12
Purpose of Long-Term Loans...........................................................................................................12
Education Loan..............................................................................................................................12
Car Loan........................................................................................................................................13
Home Loan.....................................................................................................................................13
Personal Loans...............................................................................................................................13
Features of Long-Term Loans..........................................................................................................13
High loan amount..........................................................................................................................13
Collaterals......................................................................................................................................13
EMIs...............................................................................................................................................13
 Attractive rate of interest..............................................................................................................14
Tax Benefit.....................................................................................................................................14
Benefits of Long-Term Loans...........................................................................................................14
Lower interest rate........................................................................................................................14
Maintain liquidity..........................................................................................................................14
Flexibility........................................................................................................................................14
Tax Benefits....................................................................................................................................14
Online Application.........................................................................................................................14
Uses for Long-Term Financing.....................................................................................................14
Lease financing..................................................................................................................................15
Types..................................................................................................................................................15
Operating Lease.............................................................................................................................15
Features of Operating Lease:....................................................................................................15
Finance Lease.................................................................................................................................15
Features of Finance Lease:........................................................................................................15
Advantages and Disadvantages of Lease Financing:......................................................................16
Advantages:........................................................................................................................................16
a. To Lessor:...............................................................................................................................16
Assured Regular Income:..........................................................................................................16
Preservation of Ownership:......................................................................................................16
Benefit of Tax:............................................................................................................................16
High Profitability:......................................................................................................................16
High Potentiality of Growth:....................................................................................................16
Recovery of Investment:............................................................................................................16
b. To Lessee:...................................................................................................................................16
Use of Capital Goods:................................................................................................................17
Tax Benefits:..............................................................................................................................17
Cheaper:.....................................................................................................................................17
Technical Assistance:.................................................................................................................17
Inflation Friendly:.....................................................................................................................17
Ownership:.................................................................................................................................17
ii. Disadvantages:...............................................................................................................................17
a. To Lessor:...................................................................................................................................17
Unprofitable in Case of Inflation:.............................................................................................17
Double Taxation:.......................................................................................................................17
Greater Chance of Damage of Asset:.......................................................................................17
 b. To Lessee:...................................................................................................................................17
Compulsion:...............................................................................................................................17
Ownership:.................................................................................................................................18
Costly:.........................................................................................................................................18
Understatement of Asset:..........................................................................................................18

What are liabilities?

Liabilities are current debts your business owes to
other businesses, organizations, employees,
vendors, or government agencies. You typically
incur liabilities through regular business
operations. Your liabilities continuously go up
and down. If you have more debts, you’ll have
higher liabilities. Paying off your debts helps lower your business’s liabilities. With
liabilities, you typically receive invoices from vendors or organizations and pay off your
debts at a later date. The money you owe is considered a liability until you pay off the
invoice. Loans are also considered liabilities. You can take out loans to help expand your
small business. A loan is considered a liability until you pay back the money you borrow to a
bank or person.

How Liabilities Work

In general, a liability is an obligation between one party and another not yet completed or
paid for. In the world of accounting, a financial liability is also an obligation but is more
defined by previous business transactions, events, sales, exchange of assets or services, or
anything that would provide economic benefit at a later date. Current liabilities are usually
considered short-term (expected to be concluded in 12 months or less) and non-current
liabilities are long-term (12 months or greater).
Liabilities are categorized as current or non-current depending on their temporality. They can
include a future service owed to others (short- or long-term borrowing from banks,
individuals, or other entities) or a previous transaction that has created an unsettled
obligation. The most common liabilities are usually the largest like accounts payable and
bonds payable. Most companies will have these two-line items on their balance sheet, as they
are part of ongoing current and long-term operations.
Liabilities are a vital aspect of a company because they are used to finance operations and
pay for large expansions. They can also make transactions between businesses more efficient.
For example, in most cases, if a wine supplier sells a case of wine to a restaurant, it does not
demand payment when it delivers the goods. Rather, it invoices the restaurant for the
purchase to streamline the drop-off and make paying easier for the restaurant. The
outstanding money that the restaurant owes to its wine supplier is considered a liability. In
contrast, the wine supplier considers the money it is owed to be an asset.

Types of Liabilities on
the Balance Sheet
The two main categories of liabilities
on the balance sheet are:
 Short-term liabilities – short
term liabilities (also known as
current liabilities) are any debts
that will be paid within a year.
 Long-term liabilities – long
term liabilities (also known as
non-current liabilities) are any
debts that will take more than a
year to be paid.
 Contingent liabilities – contingent liabilities are not used as often but they are the
third most common type seen on a balance sheet. Contingent liabilities include any
 potential lawsuits or product and equipment warranties and are only recorded if they
are likely to occur.

Short-term Liabilities
Short term liabilities are obligations that need to be paid within a years’ time, which is why
they are called short-term or current liabilities. Management should keep a close eye on short
term liabilities to make sure the company has enough liquidity to meet the obligations of
these liabilities within the shorter period of time.
Here are the most common types of short-term liabilities:
 Accounts payable
 Income taxes payable
 Interest payable
 Accrued expenses
 Unearned revenue
 Short-term loans

Accounts Payable
The only type of liabilities that many small businesses have on their balance sheet in the
beginning are accounts payable. This account represents debts owed to vendors, utilities, and
suppliers that have been purchased on Net terms or on credit. Most accounts payable terms
are Net15 or Net30, while some may stretch out to Net45 or even Net60. The terms vary
depending on the vendor or supplier. Until paid, these are considered short term liabilities.

Principle and Interest Payable

Principle and Interest Payable represents any payments due towards the payment of a
mortgage or loan. While the loan itself is considered a long-term liability, the principle and
interest payments are considered short term liabilities because they are due within a set term,
usually less than a year. While the loan may be a 30-year loan, most loan payments, which
include principle and interest, are due every 30 days, which makes them a short-term liability.

Short-term Loans
Loans that are due within a year (12-month time frame) are considered short term loans.
Some examples of short-term loans could be a personal line of credit that needs to be paid in
full within 12 months, bank overdrafts, trade credits, etc.

Taxes Payable
Taxes are paid on a monthly, quarterly, or annual basis, depending on your payment schedule
and tax jurisdiction but both state and income taxes are short term liabilities.

Accrued Expenses
Accrued expenses are used to allocate expenses that have been built up over time and are due
to be paid within a years’ time. This type of short-term liability is only used if you are using
the accrual method of accounting.
Example
For example, your internet bill may only be billed on a quarterly basis, but you need to
account for the expense on your balance sheet for each month. You would accrue the internet
expense over the months in the quarter even though the payment is not due until the end of
the quarter.
Say your average internet bill is $300 every three months. To accurately show this on your
financial statements for the accrual method of accounting, you would make an accrued
expense entry for $100 for three consecutive months: January $100, February $100, March
$100 = $300 total.
This accurately reflects your expenses for each month even though the actual payment is only
made every three months. In other words, expenses are recognized when they are incurred,
not when they are paid.

Unearned Revenue
Unearned revenue is a little different than the types of short-term liabilities we’ve discussed
so far because it is money that has been received in advance of goods or services.
Example
Examples of unearned revenue include prepayments towards a project, annual subscriptions
for software or media, monthly maintenance plans, prepaid insurance, prepaid rent, etc.

Long-term Liabilities
Long-term liabilities are debts that do not need to be paid within a 12-month period (1 year).
All long-term liabilities are due more than one year into the future and are often referred to as
non-current liabilities.

Long-term Notes Payable

Notes payable is very similar to accounts payable except for the length of the terms for
payment. When a formal loan agreement has payment terms that go beyond one year (12
months), this is a note payable.
As mentioned before, accounts payable are obligations that need to be met within a years’
time. Some common examples of notes payable could be the purchase of a company car or a
loan from a bank. A notes payable is anything with a written promise to pay a certain amount
at some future date.

Types of long-term liabilities

Deferred Taxes
While taxes are usually considered a short-term liability, there are times where they need to
be deferred for longer than a year. If for some reason you have taxes that are not due within
the next 12 months, they would be considered a long-term liability and would be allocated to
a deferred taxes account.
Bonds Payable
Bonds payable are always considered a long-term liability and they are often issued by
hospitals, local governments or utilities. Interest on bonds payable are usually paid every 6
months or annually until the agreed upon principal amount is paid.

Mortgage Payable
Mortgages are considered a long-term liability and are recorded as mortgage payable on the
balance sheet. However, the monthly principal and interest payments due are considered
currently liabilities and are recorded as such on the balance sheet.

Capital Leases
Capital leases are not as straightforward as some of the other liabilities because they involve
the leasing rather than the purchasing of equipment. The total amount of a capital lease is
recorded as a long-term asset on your balance sheet but the amount is also recorded as a long-
term liability as well.

Contingent Liabilities
As mentioned before, contingent liabilities are not as common but they do come up
occasionally and it is good to understand the basics of them. Two of the most common types
of contingent liabilities are lawsuits and product warranties. Contingent liabilities are actually
more like potential liabilities because they are recorded depending on the outcome of a future
event.

Example
For example, say your company is faced with a $200,000 lawsuit, the company will want to
incur a $200,000 contingent liability for this future event. A contingent liability is only
recorded if the probability of the liability to happen is 50%. If your company wins the lawsuit
or it is dropped, then no liability would arise.

Liabilities used in Pakistan

In Pakistan following types of liabilities are used
 Taxes payable
 Mortgages
 Bonds payable
 Short term and long-term loans
 Lease financing

Tax payable
Taxes payable refers to one or more liability accounts that
contain the current balance of taxes owed to government
entities. Once these taxes are paid, they are removed from the
taxes payable account with a debit. Many taxes payable is
paid within a short period of time, and so do not remain on an
organization’s balance sheet for long.
Examples of Taxes Payable
An example of taxes payable is the sales taxes payable account, for which the liability is
recorded at the time a customer is invoiced, with a debit to the accounts receivable account.
Another example is corporate income taxes payable, for which the liability is recorded at the
end of each accounting period, with a debit to the income tax expense account - assuming
there is a taxable profit. A third example is payroll taxes payable, for which the liability is
recorded when a payroll is calculated, with a debit to one of several possible payroll expense
accounts.

Presentation of Taxes Payable

Taxes payable are almost always considered to be current liabilities (that is, to be paid within
one year), and so are categorized within the current liabilities section of the balance sheet.
The various taxes payable accounts may be aggregated into a single "taxes payable" line item
in the balance sheet for presentation purposes.

Mortgages
The term “mortgage” refers to a loan used to purchase or
maintain a home, land, or other types of real estate. The
borrower agrees to pay the lender over time, typically in a
series of regular payments that are divided into principal and
interest. The property serves as collateral to secure the loan.
A borrower must apply for a mortgage through their preferred
lender and ensure that they meet several requirements,
including minimum credit scores and down payments.
Mortgage applications go through a rigorous underwriting
process before they reach the closing phase. Mortgage types
vary based on the needs of the borrower, such as conventional
and fixed-rate loans.

How Mortgages Work

Individuals and businesses use mortgages to buy real estate without paying the entire
purchase price up front. The borrower repays the loan plus interest over a specified number of
years until they own the property free and clear. Mortgages are also known as liens against
property or claims on property. If the borrower stops paying the mortgage, the lender can
foreclose on the property.

Example
For example, a residential homebuyer pledges their house to their lender, which then has a
claim on the property. This ensures the lender’s interest in the property should the buyer
default on their financial obligation. In the case of a foreclosure, the lender may evict the
residents, sell the property, and use the money from the sale to pay off the mortgage debt.

The Mortgage Process

Would-be borrowers begin the process by applying to one or more mortgage lenders. The
lender will ask for evidence that the borrower is capable of repaying the loan. This may
include bank and investment statements, recent tax returns, and proof of current employment.
The lender will generally run a credit check as well.
If the application is approved, the lender will offer the borrower a loan of up to a certain
amount and at a particular interest rate. Homebuyers can apply for a mortgage after they have
chosen a property to buy or while they are still shopping for one, a process known as pre-
approval. Being pre-approved for a mortgage can give buyers an edge in a tight housing
market, because sellers will know that they have the money to back up their offer. Once a
buyer and seller agree on the terms of their deal, they or their representatives will meet at
what’s called a closing. This is when the borrower makes their down payment to the lender.
The seller will transfer ownership of the property to the buyer and receive the agreed-upon
sum of money, and the buyer will sign any remaining mortgage documents.

Types of Mortgages
Mortgages come in a variety of forms. The most common types are 30-year and 15-year
fixed-rate mortgages. Some mortgage terms are as short as five years, while others can run 40
years or longer. Stretching payments over more years may reduce the monthly payment, but it
also increases the total amount of interest that the borrower pays over the life of the loan.
Within the different term lengths are numerous types of home loans, including Federal
Housing Administration (FHA) loans, U.S. Department of Agriculture (USDA) loans, and
U.S. Department of Veterans Affairs (VA) loans available for specific populations that may
not have the income, credit scores, or down payments required to qualify for conventional
mortgages.
The following are just a few examples of some of the most popular types of mortgage loans
available to borrowers.

Fixed-Rate Mortgages
With a fixed-rate mortgage, the interest rate stays the same for the entire term of the loan, as
do the borrower's monthly payments toward the mortgage. A fixed-rate mortgage is also
called a traditional mortgage.

Adjustable-Rate Mortgage (ARM)

With an adjustable-rate mortgage (ARM), the interest rate is fixed for an initial term, after
which it can change periodically based on prevailing interest rates. The initial interest rate is
often a below-market rate, which can make the mortgage more affordable in the short term
but possibly less affordable long-term if the rate rises substantially. ARMs typically have
limits, or caps, on how much the interest rate can rise each time it adjusts and in total over the
life of the loan.

Interest-Only Loans
Other, less common types of mortgages, such as interest-only mortgages and payment-option
ARMs, can involve complex repayment schedules and are best used by sophisticated
borrowers. Many homeowners got into financial trouble with these types of mortgages during
the housing bubble of the early 2000s.3
Reverse Mortgages
As their name suggests, reverse mortgages are a very different financial product. They are
designed for homeowners age 62 or older who want to convert part of the equity in their
homes into cash. These homeowners can borrow against the value of their home and receive
the money as a lump sum, fixed monthly payment, or line of credit. The entire loan balance
becomes due when the borrower dies, moves away permanently, or sells the home.

Average Mortgage Rates for 2022

How much you’ll have to pay for a mortgage depends on the type of mortgage (such as fixed
or adjustable), its term (such as 20 or 30 years), any discount points paid, and interest rates at
the time. Interest rates can vary from week to week and from lender to lender, so it pays to
shop around.
Mortgage rates were at near-record lows in 2020, with rates bottoming out at a 2.66%
average on a 30-year fixed-rate mortgage for the week of Dec. 24, 2020.5 Rates continued to
stay stably low throughout 2021 and have started to climb steadily since Dec. 3, 2021.
According to the Federal Home Loan Mortgage Corp., average interest rates looked like this
as of February 2022:
 30-year fixed-rate mortgage: 3.92% (0.8 point)
 15-year fixed-rate mortgage: 3.15% (0.8 point)
 5/1 adjustable-rate mortgage: 2.98% (0.8 point)6
 A 5/1 adjustable-rate mortgage is an ARM that maintains a fixed interest rate for the
first five years, then adjusts each year after that.

Bonds Payable
One source of financing available to
corporations is long‐term bonds. Bonds
represent an obligation to repay a principal
amount at a future date and pay interest,
usually on a semi‐annual basis. Unlike notes
payable, which normally represent an amount
owed to one lender, a large number of bonds
are normally issued at the same time to
different lenders. These lenders, also known as
investors, may sell their bonds to another investor prior to their maturity.

Example of Bonds Payable

Usually public utilities issue bonds to help finance a new electric power plant, hospitals issue
bonds for new buildings, and governments issue bonds to finance projects, operating deficits,
or to redeem older bonds that are maturing. For example, a profitable public utility might
finance half of the cost of a new electricity generating power plant by issuing 30-year bonds.
If the current market interest rate for the bonds is 4%, the cost after the income tax savings
may be only 3%.
Types of bonds
There are many different types of bonds available to interested investors. Some of the more
common forms are:

Serial bonds.
Bonds issued in groups that mature at different dates. For example, $5,000,000 of serial
bonds, $500,000 of which mature each year from 5–14 years after they are issued.

Sinking fund bonds.

Bonds that require the issuer to set aside a pool of assets used only to repay the bonds at
maturity. These bonds reduce the risk that the company will not have enough cash to repay
the bonds at maturity.

Convertible bonds.
Bonds that can be exchanged for a fixed number of shares of the company's common stock.
In most cases, it is the investor's decision to convert the bonds to stock, although certain types
of convertible bonds allow the issuing company to determine if and when bonds are
converted.

Registered bonds.
Bonds issued in the name of a specific owner. This is how most bonds are issued today.
Having a registered bond allows the owner to automatically receive the interest payments
when they are made.

Bearer bonds.
Bonds that require the bondholder, also called the bearer, to go to a bank or broker with the
bond or coupons attached to the bond to receive the interest and principal payments. They are
called bearer or coupon bonds because the person presenting the bond or coupon receives the
interest and principal payments.

Secured bonds.
Bonds are secured when specific company assets are pledged to serve as collateral for the
bondholders. If the company fails to make payments according to the bond terms, the owners
of secured bonds may require the assets to be sold to generate cash for the payments.

Debenture bonds.
These unsecured bonds require the bondholders to rely on the good name and financial
stability of the issuing company for repayment of principal and interest amounts. These bonds
are usually riskier than secured bonds. A subordinated debenture bond means the bond is
repaid after other unsecured debt, as noted in the bond agreement.
Short-term and long- term loan

Short-term loan
A short-term loan is a type of loan that is obtained to support a temporary personal or
business capital need. As it is a type of credit, it involves repaying the principle amount with
interest by a given due date, which is usually within a year from getting the loan. A short-
term loan is a valuable option, especially for small businesses or start-ups that are not yet
eligible for a credit line from a bank. The loan involves lower borrowed amounts, which may
range from $100 to as much as $100,000. Short term loans are suitable not only for
businesses but also for individuals who find themselves with a temporary, sudden cash flow
issue.

Characteristics of Short-Term Loans

Short term loans are called such because of how quickly the loan needs to be paid off. In
most cases, it must be paid off within six months to a year – at most, 18 months. Any longer
loan term than that is considered a medium term or long-term loan. Long term loans can last
from just over a year to 25 years. Some short-term loans don’t specify a payment schedule or
a specific due date. They simply allow the borrower to pay back the loan at their own pace.

Types of Short-Term Loans

Short term loans come in various forms, as listed below:

1. Merchant cash advances

This type of short-term loan is actually a cash advance but one that still operates like a loan.
The lender loans the amount needed by the borrower. The borrower makes the loan payments
by allowing the lender to access the borrower’s credit facility. Each time a purchase by a
customer of the borrower is made, a certain percentage of the proceeds is taken by the lender
until the loan is repaid.
2. Lines of credit
A line of credit is much like using a business credit card. A credit limit is set and the business
is able to tap into the line of credit as needed. It makes monthly installment payments against
whatever amount has been borrowed. Therefore, monthly payments due vary in accordance
with how much of the line of credit has been accessed. One advantage of lines of credit over
business credit cards is that the former typically charge a lower Annual Percentage Rate
(APR).

3. Payday loans
Payday loans are emergency short term loans that are relatively easy to obtain. Even high
street lenders offer them. The drawback is that the entire loan amount, plus interest, must be
paid in one lump sum when the borrower’s payday arrives. Repayments are typically done by
the lender taking out the amount from the borrower’s bank account, using the continuous
payment authority. Payday loans typically carry very high interest rates.

4. Online or Installment loans

It is also relatively easy to get a short-term loan where everything is done online – from
application to approval. Within minutes from getting the loan approval, the money is wired to
the borrower’s bank account.

5. Invoice financing
This type of loan is done by using a business’ accounts receivables – invoices that are, as yet,
unpaid by customers. The lender loans the money and charges interest based on the number
of weeks that invoices remain outstanding. When an invoice gets paid, the lender will
interrupt the payment of the invoice and take the interest charged on the loan before returning
to the borrower what is due to the business.

Advantages of Short-Term Loans

There are many advantages for the borrower in taking out a loan for only a brief period of
time, including the following:

1. Shorter time for incurring interest

As short-term loans need to be paid off within about a year, there are lower total interest
payments. Compared to long term loans, the amount of interest paid is significantly less.

2. Quick funding time

These loans are considered less risky compared to long term loans because of a shorter
maturity date. The borrower’s ability to repay a loan is less likely to change significantly over
a short frame of time. Thus, the time it takes for a lender underwriting to process the loan is
shorter. Thus, the borrower can obtain the needed funds more quickly.

3. Easier to acquire
Short term loans are the lifesavers of smaller businesses or individuals who suffer from less
than stellar credit scores. The requirements for such loans are generally easier to meet, in part
because such loans are usually for relatively small amounts, as compared to the amount of
money usually borrowed on a long-term basis.
Disadvantage
The main disadvantage of short-term loans is that they provide only smaller loan amounts. As
the loans are returned or paid off sooner, they usually involve small amounts, so that the
borrower won’t be burdened with large monthly payments.

Key Takeaways
Short term loans are very useful for both businesses and individuals. For businesses, they
may offer a good way to resolve sudden cash flow issues. For individuals, such loans are an
effective source of emergency funds.

Long-Term Loans
For most people, the major milestones in life like higher education, marriage, starting a
business or buying a car can be achieved only with the help of some additional financial
assistance. Long-term loans help in seeing through these moments that are cherished for a
lifetime. The right type of loan with comfortable payment terms can make financial
obligations an easy affair. Long-term loans are typically defined as loans that have a longer
tenure exceeding one year and can go up to 30 years. Different types of loans like education
loans, car loans, home loans and certain kind of personal loans fall into this category.
Because of the longer tenure, the interest rates are lower and many terms & conditions tend to
be relaxed as compared to short term or quick loans. The purpose of the loan determines the
general terms under which it would be made available to the applicant. All banks and
financial institutions offer different types of loans to suit varying needs of the common man.
Unlike yesteryears where taking a loan was considered a taboo, today, it is one of the most
accessible and viable financial assistances available. Without blocking the liquidity in your
financial portfolio, an appropriate loan can make life easier and milestones achievable
without stress.

Long-Term Financing Example

MGP Ingredients: Obtained long-term financing for expansion and growth
For MGP Ingredients, Inc. (“MGP”), investing in capex and their product inventory is
instrumental to their long-term business strategy. Headquartered in Atchison, KS, MGP is a
producer and supplier of premium distilled spirits, specialty wheat protein and starch food
ingredients. Prudential Private Capital’s relationship with MGP began in early 2017 with a
meeting to discuss MGP’s business model as well as future capital needs. MGP had
previously used a combination of cash flow generation and borrowings under its bank credit
line (‘revolver’) to fund a warehouse expansion project and to build up aged whiskey
inventory. In 2017, MGP elected to borrow long-term, fixed-rate senior debt to term-out a
portion of its revolver borrowings, and to fund incremental investment in capex and aged
whiskey inventory. Having long-term useful lives, these investments were aligned with the
long-term financing the company was looking for.
MGP obtained a $75 million Pru-Shelf facility from Prudential Private Capital, and received
an initial draw of $20 million of long-term, fixed-rate senior debt. MGP was ultimately able
to maintain a close-knit lender group, with a single capital provider for fixed-rate debt. They
also valued Prudential Private Capital’s relationship-focused approach and the ability of the
long-term financing to support the company’s future growth plans. Essentially, the type of
capital companies select will depend on the needs of their business. Long-term capital is
better-suited for external and internal strategic investments as well as financial risk
management, in contrast to short-term capital, which is best used for every-day, operational
needs. At Prudential Private Capital, we know it can be difficult to know which option is the
right choice; we are here to help companies access the type of capital that sets them up to
grow for the long run.

Purpose of Long-Term Loans

Long-term loans help in meeting major financial requirements such as marriage, building a
house or setting up a business. It has become one of the most popular financial instruments as
banks offer various options that help you choose the correct loan that suits your financial
requirement. A snapshot of various long-term loans has been mentioned below:

Education Loan
This type of loan is taken to fund specific courses like engineering or medical and also for
studying abroad. The loan tenure varies between 3 and 30 years. Depending on the type of
course being pursued and the location, the bank will offer suitable terms and conditions. The
loan amount will also be depending on the tuition fee and other expenses that could be
incurred during the course of education. Many a time, the applicant’s children graduate from
the course and start repaying the EMIs after they land up with an employment opportunity.

Car Loan
One of the easiest loans to get, a car loan is the most popular amongst all financial
instruments. Banks have made the process of applying and receiving a car loan without any
hassles. Car loans are the best way to purchase a new car or a used car as it offers easy and
immediate finance to the purchaser. The loan tenure varies from 2 to 7 years. Because of stiff
competition in the market, the rate of interest can be negotiated with your preferred bank on
the basis of your income details and other liabilities. There is also an option for pre-closure of
the loan however, some charges could be applicable.

Home Loan
Home loans are probably the longest loans available in the market due to its tenure and
amount borrowed. A home loan tenure usually varies between 3 and 30 years. The interest
rate and the amount taken depends on the credit history of the applicant and the income
source. This type of loan is secured loan and a collateral is required by the bank. The
applicants have an option to choose between fixed or floating rate of interest. One can also
avail tax exemption if you are repaying a home loan.

Personal Loans
This type of loan has a long tenure of more than 3 years and can have selective cap on the
principal amount being borrowed. The rate of interest is on the higher side as this loan is an
unsecured loan. The bank does not require a collateral for a personal loan. Hence, the chances
of default payment are high. A personal loan helps in meeting a financial contingency or an
emergency when funds are required immediately. One can also apply for this loan online with
less paperwork.
Features of Long-Term Loans
Long-term loans are planned borrowings and repayment is scheduled over a long period of
time. Some of the main features of long-term loans have been mentioned below:

High loan amount

Long-term loans offer higher principal amount to be borrowed as against a quick loan or a
short-term loan. Depending on one’s financial capabilities, the bank will be able to offer
higher loan amounts.

Collaterals
Long-term loans are offered only if a collateral has been shared. This makes the loan secure
and reduces the risk of defaulting by the applicant. In case, the borrower is not able to repay
the loan, the bank can take over the asset that has been kept as collateral to close the loan.

EMIs
One can repay the long-term loan by making Equated Monthly Instalments (EMIs) over an
agreed period of time with the bank. The instalments are made up of two elements – principal
amount and the interest. The EMIs can be paid through post-dated cheques or by giving the
bank standing instructions to deduct the amount from the savings account on a monthly basis.

Attractive rate of interest

Due to the quantum of the loan and the longer tenure involved, the rate of interest tends to be
lower than other types of loans. Stiff competition in the market also ensures lower interest
rates being offered by the bank.

Tax Benefit
Some of the long-term loans have the benefit of tax exemption. Home loan is one such loan
product which offers this benefit. A car loan does not have this benefit of tax exemption.

Benefits of Long-Term Loans

When you have a planned financial requirement, taking a long-term loan is a prudent option.
Some of the benefits of taking a long-term loan has been listed below:

Lower interest rate

Due to the longer tenure and higher principal amount being borrowed, long-term loans offer
competitive and lesser rate of interest. A collateral need to be attached to avail this loan,
hence, it is a low-risk transaction for the bank.

Maintain liquidity
As your larger need is being financed through a loan, the remaining finances can be utilized
for meeting other obligations. Therefore, it eases out any financial burdens which otherwise
would have been present.

Flexibility
The nature of long-term is such that it is mostly personalized from applicant to applicant. The
tenure and interest rate can be negotiated with the bank if your documents and credit history
are in order.
Tax Benefits
Most of the long-term loans can be used for tax exemption. This helps in saving money and
utilizing it elsewhere.

Online Application
If you are current customer of the bank that you are applying a loan for, it is possible to apply
online and submit documents. This helps in easing out tedious paperwork and makes the
entire process faster.

Uses for Long-Term Financing

Long-term capital is congruent with a company’s long-term,
strategic plans. Thus, it is most commonly used to support
long-term initiatives, such as making acquisitions, opening a
new production facility, financing internal events (like share
repurchases) as well as preparing for rising interest rates;
some companies choose to operate with a minimum level of
debt on their balance sheet to maximize their balance sheet
efficiency – managing interest rate risk for this is important
and makes it a great fit for long-term capital.

Lease financing
Lease financing is one of the important sources of
medium- and long-term financing where the owner of
an asset gives another person, the right to use that asset
against periodical payments. The owner of the asset is
known as lessor and the user is called lessee. The
periodical payment made by the lessee to the lessor is
known as lease rental. Under lease financing, lessee is
given the right to use the asset but the ownership lies
with the lessor and at the end of the lease contract, the
asset is returned to the lessor or an option is given to the lessee either to purchase the asset or
to renew the lease agreement.

Types
Operating Lease
Operating Lease: A lease is classified as an operating
lease if it does not secure for the lessor the recovery of
capital outlay plus a return on the funds invested during
the lease term. Normally, these are callable lease and
are cancelable with proper notice. The term of this type
of lease is shorter than the asset’s economic life. The
lease is obliged to make payment until the lease expiration, which approaches useful life of
the asset. An operating lease is particularly attractive to companies that continually update or
replace equipment and want to use equipment without ownership, but also want to return
equipment at lease end and avoid technological obsolescence.
Features of Operating Lease:
Operating lease has following features:
1. The lease term is much lower than the economic life of the asset.
2. The lessee has the right to terminate the lease by giving a short notice and no penalty is
charged for that.
3. The lessor provides the technical knowhow of the leased asset to the lessee.
4. Risks and rewards incidental to the ownership of asset are borne by the lessor.
5. Lessor has to depend on leasing of an asset to different lessee for recovery of his/her
investment.

Finance Lease
Finance Lease: In contrast to an operating lease, a financial lease is longer term in nature and
non-cancelable. In general term, a finance lease can be regarded as any leasing arrangement
that is to finance the use of equipment for the major parts of its useful life. The lessee has the
right to use the equipment while the lessor retains legal title. It is also called capital lease, at it
is nothing but a loan in disguise. Thus, it can be said, a contract involving payments over an
obligatory period of specified sums sufficient in total to amortize the capital outlay of the
lessor and give some profit.

Features of Finance Lease:

A finance lease is a device that gives the lessee a right to use an asset.
2. The lease rental charged by the lessor during the primary period of lease is sufficient to
recover his/her investment.
3. The lease rental for the secondary period is much smaller. This is often known as
peppercorn rental.
Lessee is responsible for the maintenance of asset.
5. No asset-based risk and rewards is taken by lessor.
6. Such type of lease is non-cancellable; the lessor’s investment is assured.

Advantages and Disadvantages of Lease Financing:

At present leasing activity shows an increasing trend. Leasing appears to be a cost-effective
alternative for using an asset. However, it has certain advantages as well as disadvantages.

Advantages:
Lease financing has following advantages

a. To Lessor:
The advantages of lease financing from the point of
view of lessor are summarized below
Assured Regular Income:
Lessor gets lease rental by leasing an asset during the period of lease which is an assured and
regular income.

Preservation of Ownership:
In case of finance lease, the lessor transfers all the risk and rewards incidental to ownership to
the lessee without the transfer of ownership of asset hence the ownership lies with the lessor.

Benefit of Tax:
As ownership lies with the lessor, tax benefit is enjoyed by the lessor by way of depreciation
in respect of leased asset.

High Profitability:
The business of leasing is highly profitable since the rate of return based on lease rental, is
much higher than the interest payable on financing the asset.

High Potentiality of Growth:

The demand for leasing is steadily increasing because it is one of the cost-efficient forms of
financing. Economic growth can be maintained even during the period of depression. Thus,
the growth potentiality of leasing is much higher as compared to other forms of business.

Recovery of Investment:
In case of finance lease, the lessor can recover the total investment through lease rentals.

b. To Lessee:
The advantages of lease financing from the point of view of lessee are discussed below:

Use of Capital Goods:

A business will not have to spend a lot of money for acquiring an asset but it can use an asset
by paying small monthly or yearly rentals.

Tax Benefits:
A company is able to enjoy the tax advantage on lease payments as lease payments can be
deducted as a business expense.

Cheaper:
Leasing is a source of financing which is cheaper than almost all other sources of financing.

Technical Assistance:
Lessee gets some sort of technical support from the lessor in respect of leased asset.

Inflation Friendly:
Leasing is inflation friendly; the lessee has to pay fixed number of rentals each year even if
the cost of the asset goes up.

Ownership:
After the expiry of primary period, lessor offers the lessee to purchase the assets— by paying
a very small sum of money.
ii. Disadvantages:
Lease financing suffers from the following disadvantages

a. To Lessor:
Lessor suffers from certain limitations which are discussed below:

Unprofitable in Case of Inflation:

Lessor gets fixed amount of lease rental every year and they cannot increase this even if the
cost of asset goes up.

Double Taxation:
Sales tax may be charged twice:
First at the time of purchase of asset and second at the time of leasing the asset.

Greater Chance of Damage of Asset:

As ownership is not transferred, the lessee uses the asset carelessly and there is a great chance
that asset cannot be useable after the expiry of primary period of lease.

b. To Lessee:
The disadvantages of lease financing from lessee’s point of view are given below:

Compulsion:
Finance lease is non-cancellable and even if a company does not want to use the asset, lessee
is required to pay the lease rentals.

Ownership:
The lessee will not become the owner of the asset at the end of lease agreement unless he
decides to purchase it.

Costly:
Lease financing is more costly than other sources of financing because lessee has to pay lease
rental as well as expenses incidental to the ownership of the asset.

Understatement of Asset:
As lessee is not the owner of the asset, such an asset cannot be shown in the balance sheet
which leads to understatement of lessee’s asset.