7e 9 Current Liabilities Contingencies and the Time
7/e 9 Current Liabilities, Contingencies, and the Time Value of Money Power. Point Author: Catherine Lumbattis COPYRIGHT © 2011 South-Western/Cengage Learning
Starbucks Corp. Partial Balance Sheet (in millions) Liabilities and shareholders' equity September 2008 Current liabilities: Commercial paper and short term borrowings $ 713. 0 Accounts payable 324. 9 Accrued compensation and related costs 253. 6 Accrued occupancy costs 136. 1 Accrued taxes 76. 1 Insurance reserves 152. 5 Other accrued expenses 164. 4 Requires Deferred revenue 368. 4 Current portion of long term debt within. 7 payment Total current liabilities $2, 189. 7 one year
Selected 2008 Liquidity Ratios Starbucks Caribou Coffee Green Mountain Industry Current Ratio Food . 80. 88 2. 09 Quick Ratio. 30. 56. 76 LO 1
Accounts Payable v Amounts owed for the purchase of inventory, goods, or services on credit v Discount payment terms offered to encourage early payment 2/10, n 30
Promissory Note I promise to pay $1, 000 plus 12% annual interest on December 31, 2011. Date: January 1, 2011 Coffee Inc. Signed: Hot _____ S. J. Devona Total repayment = $1, 120 $1, 000 + ($1, 000 × 12%)
Discounted Promissory Note In exchange for $880 received today, I promise to pay $1, 000 on December 31, 2011. Date: January 1, 2011 Coffee, Inc. Signed: Hot _____ Effective interest rate on note = 13. 6% ($120 interest/$880 proceeds)
Balance Sheet Presentation of Discounted Notes Discount transferred to interest expense over life of note 1/1/11 Notes Payable $1, 000 Less: Discount on Notes Payable 120 Net Liability $ 880 12/31/11 $1, 000 - 0 $1, 000
Current Maturities of Long-term Debt Principal repayment on borrowings due within one year of balance sheet date Due in upcoming year
Taxes Payable Record expense when incurred, not when paid 12/31/10 Record 2007 tax expense 3/15/11 Taxes Paid LO 2
Other Accrued Liabilities Includes any amount that has been incurred dueto the passage of time but has not been paid as of the balance sheet date Examples: v Salaries and Wages v Interest Adjusting Entry: Expense Payable XXX
IFRS and Current Liabilities The U. S. and international standards are generally similar but there are important differences. Differences: v International accounting standards require companies to present classified balance sheets with liabilities as either current or long term. v An unclassified balance sheet based on the order of liquidity is acceptable only when it provides more reliable information. v U. S. standards do not require a classified balance sheets. U. S. standards permit companies to list liabilities in order by size or by order of liquidity.
Current Liabilities on the Statement of Cash Flows Operating Activities Net income Increase in current liability Decrease in current liability Investing Activities Financing Activities Increase in notes payable Decrease in notes payable xxx + – LO 3
Contingent Liabilities v Obligation involving existing condition v Outcome not known with certainty v Dependent upon some future event v Actual amount is estimated LO 4
Contingent Liabilities v Accrue estimated amount if: • Liability is probable • Amount can be reasonably estimated In year criteria are met: Expense (loss) XXX Liability XXX
Typical Contingent Liabilities ® Product warranties and guarantees ® Premium or coupon offers ® Lawsuits
Recording Contingent Liabilities Example: Quickkey Computer sells a computer product for $5, 000 with a one-year warranty. In 2010, 100 computers were sold for a total sales revenue of $500, 000. Analyzing past records, Quickkey estimates that repairs will average 2% of total sales.
Recording Contingent Liabilities Probable liability has been incurred? YES Amount reasonably estimable? YES Record in 2010: Warranty Expense Estimated Liability (2% X $500, 000 sales) 10, 000
Disclosing Contingent Liabilities IF not probable but reasonably possible OR amount not estimable Disclose in Financial Statement notes
Contingent Assets v Contingent gains and assets are not recorded but may be disclosed in financial statement notes v Conservatism principle applies
IFRS and Contingencies v International standards use the term “provision” for those items that must be reported on the balance sheet v International standards have a lower threshold for those items that must be reported so thus more items will be recorded on the balance sheet. v International standards require the amount of the recorded liability be discounted (recorded at present value). v The term “contingent liability” is only used for those items that are footnoted but not for those liabilities reported on the balance sheet.
Time Value of Money v Prefer payment at the present time rather than in the future due to the interest factor v Applicable to both personal and business decisions
in lla te r re am st o pe un t r ye of In te ar re Pr st in ra cip te al as a pe rc en ta Ti ge m e in ye ar s Do Simple Interest I=P×R×T LO 5
Example of Simple Interest Given following data: principal amount = $ 3, 000 annual interest rate = 10% term of note = 2 years Calculate interest on the note.
Example of Simple Interest Given following data: principal amount annual interest rate term of note = $ 3, 000 = 10% = 2 years Calculate interest on the note. P × R × T $3, 000 ×. 10 × 2 = $ 600
Compound Interest v Interest is calculated on principal plus previously accumulated interest • Interest on interest v Compound interest amount always higher than simple interest due to interest on interest
Example of Interest Compounding Given following data: principal amount = $ 3, 000 annual interest rate = term of note = 2 years 10% semiannual compounding of interest Calculate interest on note. LO 6
Compound Interest Periods Year 1 5% + 5% semiannually 10% annually Year 2 5% + 5% semiannually 10% annually 4 periods @ 5% semiannual interest
Example of Interest Compounding Period Principal Amount at Beginning of Year 1 $3, 000 $150 $3, 150 2 3, 150 158 3, 308 3 3, 308 165 3, 473 4 3, 473 174 3, 647 Interest at Accumulated 5% per Period at End of Period
Comparing Interest Methods Simple annual interest: $3, 000 ×. 10 × 2 = $600 Semiannual compounding: 1 $150 2 158 3 165 4 174 Total $647
Compound Interest Computations Present value of a single amount Future value of a single amount Present value of an annuity Future value of an annuity
Future Value of Single Amount Known amount of single payment or investment + Interest = Future Value
Future Value of a Single Amount Example: If you invest $2, 000 today @ 10% compound interest, what will it be worth 2 years from now? Invest $2, 000 Year 1 Future Value = ? Year 2 + Interest @ 10% per year
Future Value of a Single Amount: Using Formulas FV = p(1 + i)n = $2, 000(1. 10)2 = $2, 420
Future Value of a Single Amount Example: Using Tables Year 1 Year 2 PV = $2, 000 FV = Present value × table factor = $2, 000 × (2 periods @ 10%) FV = ? ?
Future Value of $1 (n) 1 2 3 4 5 6 7 8 2% 1. 020 1. 040 1. 061 1. 082 1. 104 1. 126 1. 149 1. 172 4% 1. 040 1. 082 1. 125 1. 170 1. 217 1. 265 1. 316 1. 369 6% 1. 060 1. 124 1. 191 1. 262 1. 338 1. 419 1. 504 1. 594 8% 1. 080 1. 166 1. 260 1. 360 1. 470 1. 587 1. 714 1. 851 10% 1. 100 1. 210 1. 331 1. 464 1. 611 1. 772 1. 949 2. 144 12% 1. 120 1. 254 1. 405 1. 574 1. 762 1. 974 2. 211 2. 476 15% 1. 150 1. 323 1. 521 1. 749 2. 011 2. 313 2. 660 3. 059
Future Value of a Single Amount: Using Tables Year 1 PV = $2, 000 Year 2 FV = $2, 420 FV = Present value × table factor = $2, 000 × (2 periods @ 10%) = $2, 000 × 1. 210 = $2, 420
Present Value of Single Amount Known amount of single payment in future Present Value Discount
Present Value of a Single Amount Example: If you will receive $2, 000 in two years, what is it worth today (assuming you could invest at 10% compound interest)? Present Value = ? $2, 000 Year 1 Year 2 Discount @ 10%
Present Value of a Single Amount: Using Formulas PV = Future value × (1 + i)–n = $2, 000 × (1. 10)– 2 = $1, 652
Present Value of a Single Amount: Using Tables PV = ? ? Year 1 Year 2 FV = $2, 000 PV = Future value × table factor = $2, 000 × (2 periods @ 10%)
Present Value of $1 (n) 1 2 3 4 5 6 7 8 2% 0. 980 0. 961 0. 942 0. 924 0. 906 0. 888 0. 871 0. 853 4% 0. 962 0. 925 0. 889 0. 855 0. 822 0. 790 0. 760 0. 731 6% 0. 943 0. 890 0. 840 0. 792 0. 747 0. 705 0. 665 0. 627 8% 0. 926 0. 857 0. 794 0. 735 0. 681 0. 630 0. 583 0. 540 10% 0. 909 0. 826 0. 751 0. 683 0. 621 0. 564 0. 513 0. 467 12% 0. 893 0. 797 0. 712 0. 636 0. 567 0. 507 0. 452 0. 404 15% 0. 870 0. 756 0. 658 0. 572 0. 497 0. 432 0. 376 0. 327
Present Value of a Single Amount Example – Using Tables PV = $1, 652 Year 1 Year 2 PV = Future value × table factor = $2, 000 × (2 periods @ 10%) = $2, 000 × 0. 826 = $1, 652 FV = $2, 000
Future Value of an Annuity Periods 1 $0 2 $3, 000 3 $3, 000 4 $3, 000 + Interest Future Value = ?
Future Value of an Annuity Example: If we invest $3, 000 each year four years at 10% compound interest, what will it be worth 4 years from now? Year 1 $0 Year 2 $3, 000 Year 3 $3, 000 Year 4 $3, 000 FV = ? ?
Future Value of an Annuity Example: Year 1 $0 $3, 000 Year 2 Year 3 $3, 000 Year 4 $3, 000 FV = ? ? FV = Payment × table factor = $3, 000 × (4 periods @ 10%)
Future Value of Annuity of $1 (n) 1 2 3 4 5 6 7 8 2% 1. 000 2. 020 3. 060 4. 122 5. 204 6. 308 7. 434 8. 583 4% 1. 000 2. 040 3. 122 4. 246 5. 416 6. 633 7. 898 9. 214 6% 1. 000 2. 060 3. 184 4. 375 5. 637 6. 975 8. 394 9. 897 8% 1. 000 2. 080 3. 246 4. 506 5. 867 7. 336 8. 923 10. 637 10% 1. 000 2. 100 3. 310 4. 641 6. 105 7. 716 9. 487 11. 436 12% 15% 1. 000 2. 120 2. 150 3. 374 3. 473 4. 779 4. 993 6. 353 6. 742 8. 115 8. 754 10. 089 11. 067 12. 300 13. 727
Future Value of an Annuity Example: Year 1 $0 Year 2 $3, 000 Year 3 $3, 000 Year 4 $3, 000 PV = Payment × table factor = $3, 000 × (4 periods @ 10%) = $3, 000 × 4. 641 = $13, 923 $3, 000 FV = $13, 923
Present Value of an Annuity Periods 1 $0 2 $4, 000 3 $4, 000 Discount Present Value = ? 4 $4, 000
Present Value of an Annuity Example: What is the value today of receiving $4, 000 at the end of the next 4 years, assuming you can invest at 10% compound annual interest? Year 1 $0 PV = ? ? Year 2 $4, 000 Year 3 $4, 000 Year 4 $4, 000
Present Value of an Annuity Example: Year 1 $0 Year 2 $4, 000 Year 3 $4, 000 Year 4 $4, 000 PV = ? ? PV = Payment × table factor = $4, 000 × (4 periods @ 10%) $4, 000
Present Value of Annuity of $1 (n) 1 2 3 4 5 6 7 8 2% 0. 980 1. 942 2. 884 3. 808 4. 713 5. 601 6. 472 7. 325 4% 0. 962 1. 886 2. 775 3. 630 4. 452 5. 242 6. 002 6. 733 6% 0. 943 1. 833 2. 673 3. 465 4. 212 4. 917 5. 582 6. 210 8% 0. 926 1. 783 2. 577 3. 312 3. 993 4. 623 5. 206 5. 747 10% 0. 909 1. 736 2. 487 3. 170 3. 791 4. 355 4. 868 5. 335 12% 0. 893 1. 690 2. 402 3. 037 3. 605 4. 111 4. 564 4. 968 15% 0. 870 1. 626 2. 283 2. 855 3. 352 3. 784 4. 160 4. 487
Present Value of an Annuity Example: Year 1 $0 Year 2 $4, 000 Year 3 $4, 000 PV = $12, 680 PV = Payment × table factor = $4, 000 × (4 periods @ 10%) = $4, 000 × 3. 170 = $12, 680 Year 4 $4, 000
Solving for Unknowns Example Assume that you have just purchased a new car for $14, 420. Your bank has offered you a 5 -year loan, with annual payments of $4, 000 due at the end of each year. What is the interest rate being charged on the loan? Year 1 Year 2 Year 3 Year 4 Year 5 $0 $4, 000 $4, 000 Discount PV = $14, 420 LO 7
Solving for Unknowns Example Year 1 $0 Year 2 $4, 000 Year 3 $4, 000 Year 4 $4, 000 Year 5 $4, 000 PV = $14, 420 PV = Payment × table factor Rearrange equation to solve for unknown Table factor = PV/payment $4, 000
Solving for Unknowns Example Year 1 $0 Year 2 Year 3 $4, 000 Year 4 $4, 000 Year 5 $4, 000 PV = $14, 420 Table factor = PV/payment = $14, 420/$4, 000 = 3. 605 $4, 000
Present Value of Annuity of $1 (n) 1 2 3 4 5 6 7 8 2% 0. 980 1. 942 2. 884 3. 808 4. 713 5. 601 6. 472 7. 325 4% 0. 962 1. 886 2. 775 3. 630 4. 452 5. 242 6. 002 6. 733 6% 0. 943 1. 833 2. 673 3. 465 4. 212 4. 917 5. 582 6. 210 8% 10% 0. 926 0. 909 1. 783 1. 736 2. 577 2. 487 3. 312 3. 170 3. 993 3. 791 4. 623 4. 355 5. 206 4. 868 5. 747 5. 335 12% 0. 893 1. 690 2. 402 3. 037 3. 605 4. 111 4. 564 4. 968 15% 0. 870 1. 626 2. 283 2. 855 3. 352 3. 784 4. 160 4. 487 The factor of 3. 605 equates to an interest rate of 12%
Appendix Accounting Tools: Using Excel for Problems Involving Interest Calculations
Using Excel Functions v Many functions built into Excel®, including PV and FV calculations v Click on the PASTE function (fx) of the Excel toolbar or the Insert command
FV Function in Excel Example: Find the FV of a 10% note payable for $2, 000, due in 2 years and compounded annually Answer: $2, 420
PV Function in Excel Example: How much should you invest now at 10% (compounded annually) in order to have $2, 000 in 2 years? Answer: $1, 653 (rounded)
End of Chapter 9
- Slides: 61
