Slide 9-1 Current Liabilities and the Time Value of Money Chapter 9

Slide 9-2 Current liability is debt with two key features: 1. Company expects to pay the debt from existing current assets or through the creation of other current liabilities. 2. Company will pay the debt within one year or the operating cycle, whichever is longer. Current Liabilities SO 1 Explain a current liability and identify the major types of current liabilities. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes, salaries and wages, and interest payable.

Slide 9-3 To be classified as a current liability, a debt must be expected to be paid: a.out of existing current assets. b.by creating other current liabilities. c.within 2 years. d.both (a) and (b). Question SO 1 Explain a current liability, and identify the major types of current liabilities. Current Liabilities

Slide 9-4 SO 2 Describe the accounting for notes payable. Notes Payable Written promissory note. Require the borrower to pay interest. Those due within one year of the balance sheet date are usually classified as current liabilities. Current Liabilities

Slide 9-5 Illustration: Illustration: First National Bank agrees to lend $100,000 on September 1, 2010, if Cole Williams Co. signs a $100,000, 12%, four-month note maturing on January 1. When a company issues an interest-bearing note, the amount of assets it receives generally equals the note’s face value. SO 2 Describe the accounting for notes payable. Current Liabilities Sept. 1

Slide 9-6 Illustration: If Cole Williams Co. prepares financial statements annually, it makes an adjusting entry at December 31 to recognize interest. SO 2 Describe the accounting for notes payable. Current Liabilities Dec. 31 * $100,000 x 12% x 4/12 = 4,000

Slide 9-7 Illustration: At maturity (January 1), Cole Williams Co. must pay the face value of the note plus interest. It records payment as follows. SO 2 Describe the accounting for notes payable. Current Liabilities Jan. 1

Slide 9-8 SO 3 Explain the accounting for other current liabilities. Sales Tax Payable Sales taxes are expressed as a stated percentage of the sales price. Retailer collects tax from the customer. Retailer remits the collections to the state’s department of revenue. Current Liabilities

Slide 9-9 Illustration: March 25, cash register readings for Cooley Grocery show sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is: SO 3 Explain the accounting for other current liabilities. Current Liabilities Mar. 25

Slide 9-10 Illustration: Cooley Grocery rings up total receipts of $10,600. Because the amount received from the sale is equal to the sales price 100% plus 6% of sales, (sales tax rate of 6%), the journal entry is: SO 3 Explain the accounting for other current liabilities. Current Liabilities Mar. 25 Sometimes companies do not ring up sales taxes separately on the cash register.

Slide 9-11 SO 3 Explain the accounting for other current liabilities. Unearned Revenue Revenues that are received before the company delivers goods or provides services. 1.Company debits Cash, and credits a current liability account (unearned revenue). 2.When the company earns the revenue, it debits the Unearned Revenue account, and credits a revenue account. Current Liabilities

Slide 9-12 Illustration: Superior University sells 10,000 season football tickets at $50 each for its five-game home schedule. The entry for the sales of season tickets is: SO 3 Explain the accounting for other current liabilities. Aug. 6 Sept. 7 Current Liabilities Superior records the earning of revenue with the following entry.

Slide 9-13 Illustration: Wendy Construction issues a five-year, interest-bearing $25,000 note on January 1, This note specifies that each January 1, starting January 1, 2010, Wendy should pay $5,000 of the note. When the company prepares financial statements on December 31, 2009, 1.What amount should be reported as a current liability? _________ 2.What amount should be reported as a long-term liability? _______ Current Portion of Long-Term Debt Portion of long-term debt that comes due in the current year. No adjusting entry required. SO 3 Explain the accounting for other current liabilities. Current Liabilities

Slide 9-14 The term “payroll” pertains to both: Salaries - managerial, administrative, and sales personnel (monthly or yearly rate). Wages - store clerks, factory employees, and manual laborers (rate per hour). Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. SO 3 Explain the accounting for other current liabilities. Payroll and Payroll Taxes Payable Current Liabilities

Slide 9-15 Illustration: Assume Cargo Corporation records its payroll for the week of March 7 as follows: Salaries and wages expense100,000 Federal tax payable21,864 FICA tax payable7,650 State tax payable2,922 Salaries and wages payable67,564 SO 3 Explain the accounting for other current liabilities. Cash67,564 Salaries and wages payable 67,564Mar. 7 Record the payment of this payroll on March 7. Mar. 7 Current Liabilities

Slide 9-16 Payroll tax expense results from three taxes that governmental agencies levy on employers. These taxes are: FICA tax Federal unemployment tax State unemployment tax SO 3 Explain the accounting for other current liabilities. Current Liabilities

Slide 9-17 Illustration: Based on Cargo Corp.’s $100,000 payroll, the company would record the employer’s expense and liability for these payroll taxes as follows. Payroll tax expense13,850 State unemployment tax payable800 FICA tax payable7,650 Federal unemployment tax payable 5,400 SO 3 Explain the accounting for other current liabilities. Current Liabilities

Slide 9-18 Employer payroll taxes do not include: a.Federal unemployment taxes. b.State unemployment taxes. c.Federal income taxes. d.FICA taxes. Question SO 3 Explain the accounting for other current liabilities. Current Liabilities

Slide 9-19 Would you rather receive $1,000 today or a year from now? Basic Time Value Concepts Time Value of Money Today! Because of the interest factor.

Slide 9-20 Payment for the use of money. Excess cash received or repaid over the amount borrowed (principal). Variables involved in financing transaction: 1. Principal (p) - Amount borrowed or invested. 2. Interest Rate (i) – An annual percentage. 3. Time (n) - The number of years or portion of a year that the principal is borrowed or invested. Nature of Interest SO 1 Distinguish between simple and compound interest.

Slide 9-21 Interest computed on the principal only. SO 1 Distinguish between simple and compound interest. Nature of Interest Illustration: On January 2, 2010, assume you borrow $5,000 for 2 years at a simple interest of 12% annually. Calculate the annual interest cost. Interest = p x i x n = $5,000 x.12 x 2 = $1,200 FULL YEAR Illustration C-1 Simple Interest

Slide 9-22 Computes interest on  the principal and  any interest earned that has not been paid or withdrawn. Most business situations use compound interest. Nature of Interest SO 1 Distinguish between simple and compound interest. Compound Interest

Slide 9-23 Illustration: Assume that you deposit $1,000 in Bank Two, where it will earn simple interest of 9% per year, and you deposit another $1,000 in Citizens Bank, where it will earn compound interest of 9% per year compounded annually. Also assume that in both cases you will not withdraw any interest until three years from the date of deposit. Nature of Interest - Compound Interest SO 1 Distinguish between simple and compound interest. Year 1 $1, x 9%$ 90.00$ 1, Year 2 $1, x 9%$ 98.10$ 1, Year 3 $1, x 9%$106.93$ 1, Illustration C-2 Simple versus compound interest

Slide 9-24 Illustration: If you want a 9% rate of return, you would compute the future value of a $1,000 investment for three years as follows: Illustration C-4 SO 2 Solve for a future value of a single amount. Future Value of a Single Amount What table do we use?

Slide 9-25 What factor do we use? SO 2 Solve for a future value of a single amount. Future Value of a Single Amount Present ValueFactorFuture Value

Slide 9-26 What table do we use? Illustration : SO 2 Solve for a future value of a single amount. Future Value of a Single Amount

Slide 9-27 Present ValueFactorFuture Value SO 2 Solve for a future value of a single amount. Future Value of a Single Amount

Slide 9-28 SO 3 Solve for a future value of an annuity. Future value of an annuity is the sum of all the payments (receipts) plus the accumulated compound interest on them. Necessary to know 1.the interest rate, 2.the number of compounding periods, and 3.the amount of the periodic payments or receipts. Future Value of an Annuity

Slide 9-29 Illustration: Assume that you invest $2,000 at the end of each year for three years at 5% interest compounded annually. Illustration C-6 SO 3 Solve for a future value of an annuity. Future Value of an Annuity

Slide 9-30 Illustration: Invest = $2,000 i = 5% n = 3 years SO 3 Solve for a future value of an annuity. Future Value of an Annuity Illustration C-7 Solution on notes page

Slide 9-31 When the periodic payments (receipts) are the same in each period, the future value can be computed by using a future value of an annuity of 1 table. Illustration: Illustration C-8 SO 3 Solve for a future value of an annuity. Future Value of an Annuity

Slide 9-32 What factor do we use? PaymentFactorFuture Value SO 3 Solve for a future value of an annuity. Future Value of an Annuity

Slide 9-33 SO 4 Identify the variables fundamental to solving present value problems. The present value is the value now of a given amount to be paid or received in the future, assuming compound interest. Present value variables: 1.Dollar amount to be received in the future, 2.Length of time until amount is received, and 3.Interest rate (the discount rate). Present Value Concepts

Slide 9-34 What table do we use? SO 5 Solve for present value of a single amount. Present Value of a Single Amount Illustration C-10 Illustration: If you want a 10% rate of return, you can also compute the present value of $1,000 for one year by using a present value table.

Slide 9-35 What factor do we use? SO 5 Solve for present value of a single amount. Present Value of a Single Amount Future ValueFactorPresent Value

Slide 9-36 What table do we use? SO 5 Solve for present value of a single amount. Present Value of a Single Amount Illustration C-11 Illustration: If you receive the single amount of $1,000 in two years, discounted at 10%, the present value of your $1,000 is $

Slide 9-37 Future ValueFactorPresent Value What factor do we use? SO 5 Solve for present value of a single amount. Present Value of a Single Amount

Slide 9-38 SO 5 Solve for present value of a single amount. Present Value of a Single Amount Illustration: Suppose you have a winning lottery ticket and the state gives you the option of taking $10,000 three years from now or taking the present value of $10,000 now. The state uses an 8% rate in discounting. How much will you receive if you accept your winnings now? Future ValueFactorPresent Value

Slide 9-39 SO 5 Solve for present value of a single amount. Present Value of a Single Amount Illustration: Determine the amount you must deposit now in a bond investment, paying 9% interest, in order to accumulate $5,000 for a down payment 4 years from now on a new Toyota Prius. Future ValueFactorPresent Value

Slide 9-40 The value now of a series of future receipts or payments, discounted assuming compound interest. Necessary to know 1.the discount rate, 2.The number of discount periods, and 3.the amount of the periodic receipts or payments. SO 6 Solve for present value of an annuity. Present Value of an Annuity

Slide 9-41 Illustration: Assume that you will receive $1,000 cash annually for three years at a time when the discount rate is 10%. What table do we use? SO 6 Solve for present value of an annuity. Present Value of an Annuity Illustration C-14

Slide 9-42 What factor do we use? Present Value of an Annuity Future ValueFactorPresent Value SO 6 Solve for present value of an annuity.

Slide 9-43 Illustration: Kildare Company has just signed a capitalizable lease contract for equipment that requires rental payments of $6,000 each, to be paid at the end of each of the next 5 years. The appropriate discount rate is 12%. What is the amount used to capitalize the leased equipment? SO 6 Solve for present value of an annuity. Present Value of an Annuity

Slide 9-44 Illustration: Assume that the investor received $500 semiannually for three years instead of $1,000 annually when the discount rate was 10%. Calculate the present value of this annuity. Time Periods and Discounting SO 6 Solve for present value of an annuity.

Slide 9-45 SO 7 Compute the present value of notes and bonds. Two Cash Flows: Periodic interest payments (annuity). Principal paid at maturity (single-sum). Present Value of a Long-term Note or Bond ,000 $5, , ,000

Slide 9-46 Illustration: Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. Calculate the present value of the principal and interest payments. SO 7 Compute the present value of notes and bonds ,000 $5, , ,000 Present Value of a Long-term Note or Bond

Slide 9-47 Principal FactorPresent Value SO 7 Compute the present value of notes and bonds. PV of Principal Present Value of a Long-term Note or Bond

Slide 9-48 Principal FactorPresent Value SO 7 Compute the present value of notes and bonds. Present Value of a Long-term Note or Bond PV of Interest

Slide 9-49 Illustration: Assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. Present value of Principal $61,391 Present value of Interest 38,609 Bond current market value $100,000 SO 7 Compute the present value of notes and bonds. Present Value of a Long-term Note or Bond

Slide 9-50 Illustration: Now assume that the investor’s required rate of return is 12%, not 10%. The future amounts are again $100,000 and $5,000, respectively, but now a discount rate of 6% (12% / 2) must be used. Calculate the present value of the principal and interest payments. SO 7 Compute the present value of notes and bonds. Illustration C-20 Present Value of a Long-term Note or Bond

Slide 9-51 Illustration: Now assume that the investor’s required rate of return is 8%. The future amounts are again $100,000 and $5,000, respectively, but now a discount rate of 4% (8% / 2) must be used. Calculate the present value of the principal and interest payments. SO 7 Compute the present value of notes and bonds. Illustration C-21 Present Value of a Long-term Note or Bond