PowerPoint Author: Catherine Lumbattis

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COPYRIGHT © 2011 South-Western/Cengage Learning

9

Current Liabilities,Contingencies, and

the Time Value of

Money

Starbucks Corp.Partial Balance Sheet

Liabilities and shareholders' equityCurrent 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 Deferred revenue 368.4 Current portion of long term debt .7 Total current liabilities $2,189.7

(in millions)

Requires payment within

one year

September 2008

Selected 2008 Liquidity Ratios

Current Quick Industry Ratio Ratio

Starbucks Food .80 .30Caribou Coffee Food .88 .56Green Mountain Food 2.09 .76

LO1

Accounts PayableAmounts owed for the purchase of inventory, goods, or

services on creditDiscount payment terms offered to encourage early payment

Promissory Note

S.J.Devona

I promise to pay $1,000 plus 12% annualinterest on December 31, 2011.

Date: January 1, 2011

Signed: _________ Hot Coffee Inc.

Total repayment = $1,120 $1,000 + ($1,000 × 12%)

Discounted Promissory NoteIn exchange for $880 received today, I promise to pay $1,000 on December 31, 2011.

Date: January 1, 2011

Signed: _________Hot Coffee, Inc.

Effective interest rate on note = 13.6% ($120 interest/$880 proceeds)

Balance Sheet Presentation of Discounted Notes

1/1/11 12/31/11

Notes Payable $1,000 $1,000Less: Discount on Notes Payable 120 - 0 - Net Liability $ 880 $1,000

Discount transferred to interest expense

over life of note

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

Record 2007 taxexpense

Taxes Paid

12/31/10 3/15/11

LO2

Other Accrued LiabilitiesIncludes any amount that has been incurred duetothe passage of time but has not been paid as ofthe balance sheet dateExamples:Salaries and Wages Interest

Adjusting Entry: Expense XXX

Payable XXX

IFRS and Current LiabilitiesThe U.S. and international standards are generally

similar but there are important differences.Differences:

International accounting standards require companies to present classified balance sheets with liabilities as either current or long term.

An unclassified balance sheet based on the order of liquidity is acceptable only when it provides more reliable information.

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 xxx Increase in current liability + Decrease in current liability – Investing Activities Financing Activities Increase in notes payable + Decrease in notes payable –

LO3

Contingent LiabilitiesObligation involving existing conditionOutcome not known with certaintyDependent upon some future eventActual amount is estimated

LO4

Contingent LiabilitiesAccrue 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

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.

Example:

Recording Contingent Liabilities

Probable liability has been incurred?

Amount reasonably estimable?

Warranty Expense 10,000 Estimated Liability 10,000 (2% X $500,000 sales)

YES

YES

Record in 2010:

Disclosing Contingent Liabilities

IF not probable

but reasonably possible

ORamount not estimable

Disclose in Financial

Statementnotes

Contingent Assets

Contingent gains and assets are not recorded but may be disclosed in financial statement notes

Conservatism principle applies

IFRS and Contingencies International standards use the term “provision” for those

items that must be reported on the balance sheet International standards have a lower threshold for those

items that must be reported so thus more items will be recorded on the balance sheet.

International standards require the amount of the recorded liability be discounted (recorded at present value).

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

Prefer payment at the present time rather than in the future due to the interest factor

Applicable to both personal and business decisions

Simple Interest

I = P × R × T

Princip

al

Dollar a

mount of

interest per y

ear

Time in

years

Interest rate as a

percentage

LO5

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 InterestGiven following data:

principal amount = $ 3,000annual interest rate = 10%term of note = 2 years

Calculate interest on the note.

P × R × T $3,000 × .10 × 2 = $ 600

Compound Interest Interest is calculated on principal plus previously accumulated

interest• Interest on interest

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 = 10%

term of note = 2 years

semiannual compounding of interest

Calculate interest on note.LO6

Compound Interest Periods

4 periods @ 5% semiannual interest

Year 1 Year 2

10% annually 10% annually

5% + 5%semiannually

5% + 5%semiannually

Example of Interest Compounding

Principal Amount at Beginning Interest at Accumulated

Period of Year 5% per Period at End of Period

1 $3,000 $150 $3,150

2 3,150 158 3,308

3 3,308 165 3,473

4 3,473 174 3,647

Comparing Interest MethodsSimple 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 an

annuity

Future value of an

annuity

Present value of a

single amount

Future value of a single

amount

Future Value of Single Amount

Known amount of single payment or

investment Future Value

+ Interest =

Future Value of a Single Amount

If you invest $2,000 today @ 10% compoundinterest, what will it be worth 2 years from now?

Invest $2,000 Future Value = ?

+ Interest @ 10% per year

Year 1 Year 2

Example:

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

FV = Present value × table factor = $2,000 × (2 periods @ 10%)

FV = ??PV = $2,000

Year 1 Year 2

Future Value of $1 (n) 2% 4% 6% 8% 10% 12% 15% 1 1.020 1.040 1.060 1.080 1.100 1.120 1.150 2 1.040 1.082 1.124 1.166 1.210 1.254 1.323 3 1.061 1.125 1.191 1.260 1.331 1.405 1.521 4 1.082 1.170 1.262 1.360 1.464 1.574 1.749 5 1.104 1.217 1.338 1.470 1.611 1.762 2.011 6 1.126 1.265 1.419 1.587 1.772 1.974 2.313 7 1.149 1.316 1.504 1.714 1.949 2.211 2.660 8 1.172 1.369 1.594 1.851 2.144 2.476 3.059

Future Value of a Single Amount:

Using Tables

FV = Present value × table factor = $2,000 × (2 periods @ 10%) = $2,000 × 1.210 = $2,420

PV = $2,000

Year 1 Year 2

FV = $2,420

Present Value of Single Amount

Discount

Known amount of single

payment in future

Present Value

Present Value of a Single Amount

If you will receive $2,000 in two years, what is it worth today (assuming you could invest at 10% compound interest)?

$2,000

Discount @ 10%

Year 1 Year 2

Present Value = ?

Example:

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 = Future value × table factor = $2,000 × (2 periods @ 10%)

FV = $2,000PV = ??Year 1 Year 2

Present Value of $1 (n) 2% 4% 6% 8% 10% 12% 15% 1 0.980 0.962 0.943 0.926 0.909 0.893 0.870 2 0.961 0.925 0.890 0.857 0.826 0.797 0.756 3 0.942 0.889 0.840 0.794 0.751 0.712 0.658 4 0.924 0.855 0.792 0.735 0.683 0.636 0.572 5 0.906 0.822 0.747 0.681 0.621 0.567 0.497 6 0.888 0.790 0.705 0.630 0.564 0.507 0.432 7 0.871 0.760 0.665 0.583 0.513 0.452 0.376 8 0.853 0.731 0.627 0.540 0.467 0.404 0.327

Present Value of a Single Amount Example – Using

Tables

PV = Future value × table factor = $2,000 × (2 periods @ 10%) = $2,000 × 0.826 = $1,652

PV = $1,652Year 1 Year 2

FV = $2,000

Periods

FutureValue = ?

+ Interest

Future Value of an Annuity

1 2 3 4

$0 $3,000 $3,000 $3,000 $3,000

Future Value of an Annuity

If we invest $3,000 each year for four years at 10% compound interest, what will it be worth 4 years from now?

$0 $3,000 $3,000 $3,000 $3,000

Year 1 Year 2 Year 3 Year 4

FV = ??

Example:

$0 $3,000 $3,000 $3,000 $3,000

Year 1 Year 2 Year 3 Year 4

FV = ??

Future Value of an Annuity

FV = Payment × table factor = $3,000 × (4 periods @ 10%)

Example:

Future Value of Annuity of $1 (n) 2% 4% 6% 8% 10% 12% 15% 1 1.000 1.000 1.000 1.000 1.000 1.000 1.000 2 2.020 2.040 2.060 2.080 2.100 2.120 2.150 3 3.060 3.122 3.184 3.246 3.310 3.374 3.473 4 4.122 4.246 4.375 4.506 4.641 4.779 4.993 5 5.204 5.416 5.637 5.867 6.105 6.353 6.742 6 6.308 6.633 6.975 7.336 7.716 8.115 8.754 7 7.434 7.898 8.394 8.923 9.487 10.089 11.067 8 8.583 9.214 9.897 10.637 11.436 12.300 13.727

Future Value of an Annuity

PV = Payment × table factor = $3,000 × (4 periods @ 10%) = $3,000 × 4.641 = $13,923

$0 $3,000 $3,000 $3,000 $3,000

Year 1 Year 2 Year 3 Year 4

FV = $13,923

Example:

Present Value of an Annuity

1 2 3 4

$0 $4,000 $4,000 $4,000 $4,000

Periods

Discount

PresentValue = ?

Present Value of an Annuity

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?

$0 $4,000 $4,000 $4,000 $4,000

Year 1 Year 2 Year 3 Year 4

PV = ??

Example:

$0 $4,000 $4,000 $4,000 $4,000

Year 1 Year 2 Year 3 Year 4

PV = ??

Present Value of an Annuity

PV = Payment × table factor = $4,000 × (4 periods @ 10%)

Example:

Present Value of Annuity of $1 (n) 2% 4% 6% 8% 10% 12% 15% 1 0.980 0.962 0.943 0.926 0.909 0.893 0.870 2 1.942 1.886 1.833 1.783 1.736 1.690 1.626 3 2.884 2.775 2.673 2.577 2.487 2.402 2.283

4 3.808 3.630 3.465 3.312 3.170 3.037 2.855 5 4.713 4.452 4.212 3.993 3.791 3.605 3.352 6 5.601 5.242 4.917 4.623 4.355 4.111 3.784 7 6.472 6.002 5.582 5.206 4.868 4.564 4.160 8 7.325 6.733 6.210 5.747 5.335 4.968 4.487

Present Value of an Annuity

PV = Payment × table factor = $4,000 × (4 periods @ 10%) = $4,000 × 3.170 = $12,680

$0 $4,000 $4,000 $4,000 $4,000

Year 1 Year 2 Year 3 Year 4

PV = $12,680

Example:

Solving for Unknowns ExampleAssume 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?

LO7

Year 1 Year 2 Year 3 Year 4 Year 5

$0 $4,000 $4,000 $4,000 $4,000 $4,000

DiscountPV = $14,420

Solving for Unknowns Example

PV = Payment × table factor

Table factor = PV/payment

Year 1 Year 2 Year 3 Year 4 Year 5

$0 $4,000 $4,000 $4,000 $4,000 $4,000

PV = $14,420

Rearrange equation to solve for unknown

Solving for Unknowns Example

Table factor = PV/payment = $14,420/$4,000

= 3.605

Year 1 Year 2 Year 3 Year 4 Year 5

$0 $4,000 $4,000 $4,000 $4,000 $4,000

PV = $14,420

Present Value of Annuity of $1 (n) 2% 4% 6% 8% 10% 12% 15% 1 0.980 0.962 0.943 0.926 0.909 0.893 0.870 2 1.942 1.886 1.833 1.783 1.736 1.690 1.626 3 2.884 2.775 2.673 2.577 2.487 2.402 2.283

4 3.808 3.630 3.465 3.312 3.170 3.037 2.855 5 4.713 4.452 4.212 3.993 3.791 3.605 3.352 6 5.601 5.242 4.917 4.623 4.355 4.111 3.784 7 6.472 6.002 5.582 5.206 4.868 4.564 4.160 8 7.325 6.733 6.210 5.747 5.335 4.968 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 Many functions built into Excel®, including PV

and FV calculations Click on the PASTE function (fx) of the Excel

toolbar or the Insert command

FV Function in ExcelFind the FV of a 10% note payable for $2,000, due in 2 years and compounded annually

Example:

Answer:$2,420

PV Function in Excel

How much should you invest now at 10% (compounded annually) in order to have $2,000 in 2 years?

Example:

Answer:$1,653

(rounded)

End of Chapter 9