Many companies have gone digital and moved their operations online. However, most companies still need physical space to allow interactions between workers. On top of that, companies need to have a location for other needs. Companies use properties and buildings to establish this location. This space may come under a lease or rental agreement. Sometimes, companies may also acquire property.
Acquiring property requires more capital than renting or leasing it. Usually, companies fund the latter process through their operations. As companies generate revenues and profits, they use proceeds to pay rent or leases. However, the same does not apply when acquiring property. This process requires a lump sum payment. Sometimes, companies can also pay a down payment while covering the residual amount with installments.
Companies can fund their property acquisitions through several sources. In most jurisdictions, they must obtain a mortgage to acquire it. A mortgage is a liability for the company receiving it. Before discussing if it is current or non-current, it is crucial to understand the process.
What is a Mortgage?
A mortgage refers to a loan obtained by entities to fund properties. In some cases, they also use this loan to maintain their properties. These properties include any type of real estate or land. Like other loans, a mortgage involves two parties. The first is the party that obtains the mortgage to fund their property purchase. The other party is the lender that provides the funds.
In a mortgage deal, the borrower gets funds from the lender. The agreement between these parties requires the borrower to pay the lender over time. Usually, this process involves several installments over a specific period. These installments include two components, principal and interest amounts. These payments constitute income and recovery for the lender. However, they also require more from the deal.
Loans may require collateral, which constitutes secured debt. A mortgage is a type of secured loan from a lender. In this case, the underlying property that the borrower acquires serves as the collateral. If the borrower fails to repay the lender, the latter can seize the property. Borrowers cannot obtain a mortgage without offering their underlying property as collateral. These features constitute the essence of a mortgage agreement.
Like other loans, borrowers must complete a rigorous process to obtain a mortgage. Usually, they can choose between various lenders. Borrowers must choose the lender that suits their requirements and provide the best deals. However, every lender will have criteria to approve the mortgage. Once both parties agree to the transaction, they can sign an agreement commencing the process.
What Are the Types of Mortgages?
Mortgages have been prevalent for a long time. Most jurisdictions require entities to fund their property purchases through a mortgage. Over time, many types have mortgages have come forward, offering borrowers different features. Similarly, mortgages come with varying lengths, lasting as short as five years. However, longer mortgages can go even 40 years or more.
Some of the most prevalent types of mortgages include the following.
A fixed-rate mortgage comes with a fixed interest rate. Usually, these mortgages can last between 15 to 30 years. The shorter the mortgage period is, the higher the interest rate the borrower must pay. Fixed-rate mortgages allow borrowers to pay a fixed interest payment each period. It makes it easier to repay and budget these payments. Similarly, they do not force borrowers into unwanted increases in mortgage rates.
Adjustable-rate mortgages (ARM) do not come with a fixed interest rate. Instead, this rate changes over the loan’s life. Several factors can contribute to how much the adjustable rate will be. Usually, the market interest rates are the most crucial factor in dictating these rates. ARMs come with specific breaks, after which the lender reviews the interest rate and adjusts it.
Reverse mortgages are technically a type of mortgage, although they differ significantly. In this type, a homeowner converts their home equity into cash. Reverse mortgages allow individuals to borrow money against the value of their homes. They can receive the mortgage in various forms. Usually, these mortgages are prevalent for individuals aged 62 or more.
How to account for Mortgages?
Companies account for mortgages in several stages. The first involves obtaining the mortgage from a lender. Usually, this process differs based on the agreement with the lender. The company obtaining a mortgage may receive funds from the lender directly. In other cases, the lender may fund the property purchase directly. Either way, the company must create a liability for the mortgage amount.
After obtaining the mortgage, companies must pay regular interest. As mentioned above, there are several types of mortgages. Based on that type, the interest payments will differ. Nonetheless, the accounting for this process remains the same. The company paying the interest must record it as an expense. However, companies do not incur an interest expense only during this process.
For each payment, the amount will include a principal portion. The company paying this amount must separate the interest from that amount. Consequently, they must use the interest amount to increase expenses. The principal portion will reduce the overall liability in the balance sheet. Usually, the lender provides a schedule of the segregation between the amounts.
The last stage in accounting for mortgages comes when repaying the loan. This process involves removing the mortgage balance from the balance sheet completely. At this point, the liability on the balance sheet will include a minimal amount. Nonetheless, companies must remove it to illustrate a loan repayment in full. Other accounting treatments for a mortgage may also apply. However, the above stages are the crucial ones.
Is Mortgage Current Liabilities or Non-Current Liabilities?
A mortgage meets the definition for liability set by the accounting principle. It creates an obligation for a company to repay at a future date. Similarly, it comes from a past event, i.e., the agreement with the lender. On the other hand, it also results in an outflow of economic benefits in the future. This outflow occurs through installments paid to the lender. Therefore, mortgages fall under liabilities in the balance sheet.
However, accounting standards require companies to separate liabilities into current and non-current headings. This process identifies whether settling these liabilities will happen within 12 months. If it does, it will fall under current liabilities in the balance sheet. On the contrary, those with an expected settlement of over 12 months will be non-current.
Most mortgages last for a significant period. Usually, these cover any period between 10 to 30 years. Therefore, mortgages are non-current liabilities on the balance sheet. Since the expected settlement for these amounts occurs after a year, this classification is more appropriate. However, portion mortgages also appear under current liabilities on the balance sheet.
Accounting standards require companies to separate the current portion of the mortgage in the balance sheet. Companies must identify the amount payable to the lender within a year. Consequently, they must classify that amount as a current liability on the balance sheet. The majority of the mortgage will still appear under non-current liabilities. In the last year, it will only include a current portion.
A mortgage is a type of finance obtained by companies to fund property acquisitions. Essentially, it is similar to a loan in most aspects. Companies account for mortgages in several stages. They classify these debts under liabilities in the balance sheet. Usually, mortgages appear as a non-current liability balance. However, the principal amount payable within a year falls under current liabilities.